If you're looking to customize a 401(k) Plan for your particular group of employees, we need to arm you with the knowledge necessary to target specific employees within the organization and how to legally exclude other groups of employees. Let’s learn how.
The #1 reason my Plan Sponsors put their benefits packages in place is to recruit and retain higher-caliber employees. Depending on how you structure the 401(k) Plan, the eligibility requirements you select can either help you or hurt you on this mission. Setting a service requirement that is too restrictive can make it difficult for new candidates to see a value in the benefit. Conversely, setting up a plan with immediate eligibility may not reward loyalty as it gives new-hires the same level of access to the 401(k) as those employees who have been with the firm for years. So what's the right answer? In order to determine the right eligibility requirements for your particular group of employees, let's first review the various ways we can define eligibility.
If you are considering offering a company match or non-elective contribution, I might suggest you pay particular attention to the plan’s eligibility requirements as this will affect who qualifies for the company contributions and can, therefore, have a significant impact on the overall cost of the plan. However, even if you aren’t going to offer any company contributions, most retirement plan providers will charge you based n the number of participants who have a balance in the plan. Because of these factors, I usually start the eligibility conversation with the concept of “excluded classes”. As a Plan Sponsor, you have the ability to exclude certain classes of employees such as union employees, non-resident aliens, part-time and seasonal employees, those under the age of 18, highly compensated employees (making over $130,000 per year), etc.
After determining who is excluded and not eligible for the plan, we have to determine the service requirements for those who are eligible to participate. If you are considering the Safe Harbor 401(k), you will choose one service requirement for the employees to contribute a portion of their pay to the plan as well as receiving the company’s Safe Harbor contributions. If you are considering the Traditional 401(k), you can choose one service requirement for the employees to contribute a portion of their pay to the plan and another service requirement to receive the company’s contributions (if applicable). For example, under the Traditional 401(k), you could say that eligible employees must be with the company for a minimum of 6 months before they can enter the plan but they then have to wait until their 1-year anniversary to receive the company contributions. This type of structure can reward tenure as those who have a greater amount of service with the organization would realize a greater benefit. Many plan sponsors also consider aligning the eligibility to join the 401(k) Plan with the other benefits for an easier onboarding process.
If you attended last week's class, you'll remember that the Traditional 401(k) is subject to compliance testing and these tests weigh all eligible employees against one another (regardless of whether they are actually participating in the plan). Therefore, the eligibility requirements you select for your plan may have a significant effect on your compliance testing results within the Traditional 401(k). Remember that Safe Harbor plans are omitted from these compliance tests so this isn't as much of a factor within Safe Harbor plans.
It should be noted that you can only set a maximum service requirement of 12 months for the employees to enter the plan and a maximum requirement of 24 months to receive any company contributions. However, if you are trying to implement more restrictive participation requirements, you can also setup the plan with specific Plan Entry Dates. These entry sates determine when an employee can actually join the 401(k) Plan. For example, an employee may be eligible to participate but may have to wait until the first day of the quarter or twice a year to actually enter the plan.
Professor’s Tip: Many sponsors setting up a 401(k) for the first time elect for the Waiver of Eligibility Requirement. This waiver allows the sponsor to set more restrictive eligibility requirements for future employees but grandfathers all current employees into the plan regardless of whether they meet the age and/or service criteria.
Today’s class may have you walking away with more questions than answers but it’s important that you design the plan document correctly so it operates in the real world as you are envisioning it in your mind. Join us next week when we discuss how different forms of Company Contributions can incentivize the employees to increase their level of engagement in the retirement plan.