401(k) Eligibility: When to Let Employees Join Your Plan

Employee eligibility is an important but often overlooked part of 401(k) plan design.  Employers often don’t realize that they have options that may benefit both them and their employees.  Eligibility rules may have a dramatic effect on plan cost, ease of administration and perceived value to employees. 

A 401(k) provider with a strong plan design expertise can help you choose the most appropriate eligibility requirements for your business based on your plan goals and employee demographics in short order.  Understanding some eligibility basics can help you make informed choices even faster.  Here’s what you need to know.

401(k) Eligibility Basics

Eligibility defines the criteria for when an employee becomes a participant in the 401(k) plan. You may allow employees to become participants immediately or may require them to meet a minimum age or service condition first.  You may also want to keep certain employees out of your 401(k) plan altogether. 

Excluding Employee Groups

Businesses may exclude certain groups of employees from their 401(k) plan regardless of whether the employees meet any of the age or service requirements detailed below. Employers have discretion in defining the excluded group(s). For example, a 401(k) plan could exclude: 

• • Certain job classifications, like hourly or union employees; 

• • Identifiable job positions, like associate producers; or 
  • Specific divisions or units, like the Alabama office. 

Be careful when defining the excluded group. The definition cannot indirectly refer to age or service. For example, excluding part-time or seasonal workers. Referring to age or service in defining the group is impermissible because it sidesteps the minimum age or service requirements below. 

In addition, the exclusion of certain groups may cause the 401(k) plan to fail the annual coverage test, required by the IRS, which may result in additional costs and administrative burden. You should work closely with your provider if you are going to exclude employees as a group. 

Age Requirement

An employer may set a minimum age for employees to become participants which cannot exceed age 21. An employer has the discretion to set an earlier age, such as 18, or no minimum age at all. 

Service Requirement

An employer may establish a minimum service requirement before employees become participants. An employee may be required to work up to one year of service before becoming a participant. Longer service requirements, such as one year, are generally selected by businesses with high employee turnover. The ability to keep transient employees out can reduce plan costs and administrative burden. 

Lesser service requirements, including no service requirement at all, are also permitted. Shorter service requirements, or no service requirement at all, are generally selected by businesses that want their 401(k) plan to help recruit top employee talent or wish to help employees save as early as possible for retirement.  

We studied the service requirements used by 3,975 small business 401(k) plans. The two most popular requirements were 1 year of service – used by 50.33% – and none at all - used by 21.81%. When potentially selecting an age or service requirement, remember that these requirements can have a material effect on the plan’s cost, ease of administration, and perceived value to existing or prospective employees. 

Although rarely used, an employer can require an employee to wait up to two years to become a participant for match or non-elective contributions. The trade-off is that the employees are immediately vested in those contributions. The two-year service requirement is not available for elective deferral contributions. 

Entry Dates

The employer can also define when an employee enters the plan after meeting any age or service requirements. The use of entry dates may be helpful in managing enrollment meetings and delivering information to the newly eligible participants. The most used entry dates are monthly, quarterly, and semi-annually. 

For example, you have employees who met the age and service requirements on February 4th, February 22nd, and March 13th. If you had selected quarterly entry dates, then all three employees would become participants at the same time on April 1st. 

Dual Eligibility

An employer can choose different eligibility requirements for different contribution types. For example, you may allow employees to be immediately eligible to start elective deferrals upon date of hire, but the safe harbor match contribution or any employer contributions would not begin until an employee attains both age 21 and one year of service. 

Dual eligibility requirements work well for employers who want to recruit talent, but also suffer from high employee turnover. For example, you have employees who are hired in 2023 on February 4th, February 22nd, and March 13th. All are over the age of 21 and the plan uses quarterly entry dates. By using immediate eligibility for elective deferrals, these employees can begin making those contributions on April 1, 2023. However, you can use a one year of service requirement to keep these employees from being eligible for any employer contributions until April 1, 2024, assuming these employees are still with your business. 

When considering dual eligibility, make sure you understand all the implications. For example, a safe harbor 401(k) plan’s top-heavy exemption may be impacted. You should work closely with your provider if you are thinking about using dual eligibility. 

Measuring Service

If you decide to use a service requirement for eligibility, you have two methods in determining if an employee satisfies the requirement: 1. counting hours; and 2. elapsed time. 

1. Counting Hours

The counting hours method is generally used by businesses with a number of part-time or seasonal employees. The ability to keep part-time or seasonal employees out can reduce plan costs and administrative burden. 

Under this method, employees must work a specified number of hours during the eligibility computation period (ECP). An ECP cannot be more than 12 months or require more than 1,000 hours of service. The initial ECP commences on the employee’s hire date and employers may select whether subsequent ECPs commence on the 1) employee’s anniversary date or the 2) plan year (beginning with the plan year that includes the employee’s first anniversary date). 

For example, your 401(k) plan requires employees to work one year of service before becoming eligible. Your plan uses the counting hours method by defining a year of service as working 1,000 hours in a 12-month period. Your plan also states that subsequent ECPs commence on the plan year and entry dates are quarterly. 

• • Situation 1: Rebekah is hired to work full-time on April 3, 2023. Although she is likely to work over 1,000 hours by October, 2023, you do not need to determine hours worked until the end of her initial ECP on April 2, 2024. At the end of Rebekah’s initial ECP, if she has worked over 1,000 hours, she will enter the plan on July 1, 2024 (based on quarterly entry date). 

• • Situation 2:  When Rebekah is hired, she only works part-time and she does not work 1,000 hours by the end of her initial ECP of April 2, 2024. Her subsequent ECP commences on January 1, 2024, because of the plan year selection. If Rebekah works 1,000 hours from January 1st to December 31, 2024, then she enters the plan on January 1, 2025. If Rebekah doesn’t work 1,000 hours in that time period, her subsequent ECPs continue from January 1st to December 31st each subsequent year until she works over 1,000 hours and is able to enter the plan. 
  • Situation 3: When Rebekah is hired, she only works part-time and she does not work 1,000 hours by the end of her initial ECP of April 2, 2024. If you had selected an employee’s anniversary date for subsequent ECPs (instead of the plan year), Rebekah’s subsequent ECP would commence on April 3, 2024. If she works 1,000 hours from April 3rd to April 2, 2025, then she enters the plan on July 1, 2025. If Rebekah doesn’t work 1,000 hours in that time period, her subsequent ECPs continue from April 3rd to April 2nd of each subsequent year until she works over 1,000 hours and is able to enter the plan. 
    

2. Elapsed Time

The elapsed time method is usually an easier way for employers to measure service, especially for those employer who don’t want to track hours worked. Under this method, hours worked is irrelevant. Only dates of employment are important.  

For example, your 401(k) plan requires employees to work one year of service before becoming eligible, you select the elapsed time method, and entry dates are quarterly. 

• • Situation 1: Rebekah is hired to work full-time on April 3, 2023. Regardless of whether Rebekah works 1 hour or 2,000 hours, if she is still employed on April 2, 2024, then she enters the plan on July 1, 2024 (based on quarterly entry date). 
  • Situation 2: Rebekah was hired on April 3, 2023, then leaves on May 6, 2023, but is re-hired on March 15, 2024 and remain employed on April 2, 2024. She is still considered to meet the one year requirement under the elapsed time method and enters the plan on July 1, 2024. 

Long Term, Part-Time Employees

Congress wants to make it easier for people to save for retirement and one of its goals is to have as many people as possible covered by retirement plans. Congress appears to believe that long minimum service requirements, such as one year of service in which an employee works at least 1,000 hours, is a barrier to part-time employees saving for retirement. 

Two recent law changes (SECURE and SECURE 2.0) attempt to overcome that barrier by requiring “long term, part-time” (LTPT) employees to be covered by 401(k) plans. Beginning in 2024, workers meeting the LTPT employee definition must be allowed to participate your 401(k) plan.  

Defining LTPT Employees

For 2024, an LTPT employee is defined as an individual who has worked more than 500 hours in three consecutive 12-month periods. For 2025, an LTPT employee is defined as an individual who has worked more than 500 hours in two consecutive 12-month periods. If your business has employees who may meet one of the definitions, you should be tracking hours worked since 2021. 

Starting in 2024, if an LTPT employee meets one of the definitions, he or she must become a 401(k) participant, but just for the opportunity to make elective deferrals. LTPT employees are not required to receive match or non-elective contributions, including safe harbor contributions, until they meet the plan’s eligibility requirements. For example, a 401(k) plan may still require employees, including LTPT employees, to work one year of service to be eligible for employer contributions. 

For example, your 401(k) plan requires one year of service in which an employee works at least 1,000 hours to be eligible. You have set this service requirement because your business has a large group of employees that just work in the summer during busy season. Using the counting hours method and the 1,000 hours of service requirement prevent these seasonal employees from participating in the 401(k) plan. 

• • Situation 1: Rebekah has worked May, June, July and August for the last several years. Her total hours for those four months exceed 600. When she returns to work in May, 2024, she must be allowed to make elective deferrals into the 401(k) plan. However, Rebekah would not be eligible for any employer contributions, including match on elective deferrals, because she has yet to work 1,000 hours in a 12-month period. 
  • Situation 2: Rebekah is hired in 2024 to work May, June, July, and August and will likely work those months each year going forward. If she works at least 500 hours during the 2024 and 2025 busy season, Rebekah must be allowed to make elective deferrals when she returns in May, 2026. However, Rebekah would not be eligible for any employer contributions, including match on elective deferrals, because she has yet to work 1,000 hours in a 12-month period. 

Impact of LTPT Employees

Here are some features and strategies to consider for LTPT employees: 

• • No need to worry about the LTPT employee definitions if your employees don’t regularly work in the 500-1,000 hour range. 

• • If your plan already allows employees to be immediately eligible for elective deferrals, then the LTPT employee definitions are irrelevant.  
  • LTPT employees, and any elective deferrals contributed by them, are excluded from annual testing. Further, any employer contributions made to them are also excluded from annual testing. 
  • LTPT employees must still satisfy the plan’s minimum age requirement, if any. For example, your plan requires employees to be age 21 before entering the plan. Any LTPT employee who satisfies the hours requirement must still be age 21 before being eligible to make elective deferrals. 
  • IRS guidance is needed for employers using the counting hours method for their service requirement. If the employer has selected the plan year for subsequent eligibility computation periods (ECP), it is unclear if this selection applies to LTPT employees. If so, an LTPT employees service requirement may be reduced. On the other hand, if LTPT employee are permitted to have a different or separate subsequent ECP, then the full service requirement must be completed. 

As an example of the need for IRS guidance, your 401(k) plan requires employees to work one year of service before becoming eligible. Your plan defines a year of service as working 1,000 hours in a 12-month period. Your plan also states that subsequent ECPs commence on the plan year and entry dates are quarterly. 

• • Situation 1: You hire Rebekah to work 10 hours a week on April 3, 2023. On April 2, 2024, she will have worked over 500 hours for one consecutive 12-month period. If your plan’s subsequent ECP selection of plan year applies, then Rebekah’s second 12-month period began on January 1, 2024. She will have worked over 500 hours from January 1st to December 31st and be allowed to make elective deferrals as an LTPT employee on January 1, 2025 (based on quarterly entry dates). 
  • Situation 2: You hire Rebekah to work 10 hours a week on April 3, 2023. On April 2, 2024, she will have worked over 500 hours for one consecutive 12-month period. If your plan’s subsequent ECP selection of plan year does not apply, then Rebekah’s second 12-month period begins on April 3, 2024, and ends on April 2, 2025. She will have worked over 500 hours during that time period and be allowed to make elective deferrals as an LTPT employee on July 1, 2025 (based on quarterly entry dates). 

401(k) Eligibility is Important!

When eligibility requirements are too liberal, plan expenses can increase, and day-to-day administration is made unnecessarily complex.  If they are too strict, you may hinder the recruitment of prospective employees.  You should understand your options to make the right eligibility decisions for your 401(k) plan. 

Consider business goals, employee demographics, and plan features when choosing eligibility terms for your plan. Choosing the right mix of 401(k) features, including employee eligibility, during the plan design process can help a business meet their 401(k) goals. An experienced 401(k) provider, like Employee Fiduciary, will help walk you through this process.