401(k) eligibility

401(k) eligibility refers to the certain conditions employees must meet to participate in a company's 401(k) retirement plan. The plan sponsor sets these criteria within legal guidelines and typically includes factors such as age and length of service.

401(k) eligibility restrictions

The Internal Revenue Code (IRC) and the Employee Retirement Income Security Act (ERISA) establish guidelines for excluding individuals from participating in a retirement plan. Specifically, a retirement plan may exclude:

• Employees under the age of 21

• Employees who have not completed one year of service with the employer

• Certain union employees

• Nonresident aliens (those who do not reside in the US and are not paid from a US payroll)

Additionally, a retirement plan can exclude other employee classifications if the exclusion meets the following criteria:

• It is based on a reasonable business reason

• It is not directly related to the number of hours an employee is scheduled to work

• The plan can still satisfy the coverage requirements of IRC Section 410(b) ("coverage testing")

A 401(k) plan may use the maximum exclusions above, and can apply different eligibility requirements to different sources. However, plan sponsors may find that allowing employees to participate in the retirement plan sooner can be advantageous. For example, a plan sponsor may allow employees to participate after six or three months rather than require them to wait a full year. Immediate access to the 401(k) plan can make an employer more attractive to top talent, especially for candidates who prioritize comprehensive benefits packages.

Note: There are legal limitations on the exclusion of part-time employees.

Importance of 401(k) eligibility for employers

1. Compliance and administration: Understanding 401(k) eligibility is crucial for compliance with IRS regulations. Failure to adhere to eligibility rules is an operational error. Errors can be corrected, but if they aren’t addressed, can lead to penalties or plan disqualification. It also affects the complexity of plan administration, as complex eligibility criteria can lead to more administrative effort and potentially higher costs.

2. Nondiscrimination testing: Eligibility is tested annually via 410(b) coverage tests. This test reviews the availability of deferral opportunities and eligibility to receive employer contributions (taking into account allocation requirements, as applicable) between eligible highly compensated employees and non-highly compensated employees. Although most plans pass this test annually, employee exclusions and some allocation conditions can cause the plan to fail. If the plan fails this test, additional contributions may be required to be made in order to correct the situation.

3. Cost management: Eligibility criteria can help influence the cost of the 401(k) plan. For example, offering employer contributions only to employees who meet specific eligibility criteria can impact the budget allocated to retirement benefits.

4. Employee Recruitment and Retention: Offering a 401(k) plan with favorable eligibility terms can enhance employee recruitment and retention efforts. Employees often consider retirement benefits a significant factor when choosing or staying with an employer.

Importance of 401(k) eligibility for employees

1. Financial planning: Knowing when to participate in a 401(k) plan can help employees plan their retirement savings strategy. Eligibility terms can help clarify when employer contributions may start, helping them maximize their retirement savings potential.

2. Employee benefits: Eligibility criteria directly affect the scope of employee benefits. Understanding these criteria helps employees assess the overall value of the benefits package offered by their employer.

Understanding 401(k) eligibility is critical for both employers and employees to ensure compliance, manage costs, and enhance the overall benefits package offered by the employer. For more information on 401(k) plan eligibility, refer to 401(k) Plan Eligibility Basics.