One of the most fundamental requirements in managing a qualified
retirement plan is counting an employee's length of service. It is the basis
for determining such items as plan eligibility, entitlement to company
contributions, vesting and even retirement itself. Although this seems like
a straightforward task, the rules are quite complex and create traps for the
unwary.
Methods of Counting Service
Before reviewing the reasons for counting service, it is important to
understand the methods available for doing so. There are several and each
has certain advantages and disadvantages depending on how a plan sponsor
runs its business.
Elapsed Time Method
The elapsed time method credits an employee for a period of service if he
is still employed at the end of that period. For example, if Herbert is
hired on April 1, 2012, he receives credit for a year of service if still
employed on March 31, 2013. Credit is given regardless of the number of
hours Herbert works even if he terminates employment and is rehired prior to
March 31, 2013.
One of the advantages of the elapsed time method is that it is not
necessary to keep track of actual hours worked. One of the potential
disadvantages is that employees who work only limited hours may still be
credited with service they would not earn under one of the other methods,
entitling them to the same level of benefits as a full-time employee.
However, for plan sponsors who seek to benefit all employees equally, this
could also be considered an advantage.
Actual Hours Method
The actual hours method considers the hours that each employee works
and/or is entitled to payment, e.g. vacation, sick leave, jury duty, etc. An
employee is required to complete a specified number of hours in a period to
receive credit for that period. A common example is to require completion of
1,000 hours of service within a 12-month period in order to be credited with
one year of service.
Unlike elapsed time, this method requires employers to keep and review
records of the actual time each employee works. For hourly-paid employees,
records are already available, so there would be minimal additional
recordkeeping. For salaried employees, the actual hours method will likely
impose added recordkeeping. One of the advantages of this method is that it
requires all employees to work the same minimum hours of service to be
entitled to the same level of benefit under the plan.
Equivalency Method
This method is a hybrid of the first two. It credits employees with a
certain number of hours for each period they work as follows:
- 10 hours per day
- 45 hours per week
- 95 hours per semi-monthly pay period
- 190 hours per month
For a plan that uses the monthly equivalency, an employee who performs
any service in a month is treated as working 190 hours during that month. If
the plan credits a year of service as described above, i.e. 1,000 hours in a
12-month period, an employee would need to perform at least one hour of
service in at least six out of the 12 months (6 months x 190 hours per month
= 1,140 hours) to earn a year of service.
The equivalency method has the advantage of requiring continuous service
while minimizing additional recordkeeping requirements; however, similar to
the elapsed time method, it can still have the effect of crediting very
limited time employees with the same benefits as full-time workers.
Reasons for Counting Service
Now that we have reviewed the methods, it is time to cover some of the
reasons why properly counting service matters.
Initial Plan Eligibility
Many plans require employees to satisfy certain age and/or service
requirements to become eligible. If there is a service requirement, the plan
must specify how to determine when an employee has satisfied it. In plans
that use the elapsed time method for eligibility, measuring the service
requirement can be straightforward. For example, if a plan requires
employees to complete six months of service to be eligible, any employee who
remains employed six months after his hire date has satisfied the service
requirement as of that date. Similarly, if the plan requires completion of
one year of service, employees satisfy the requirement if they are still
employed a year after they are hired.
There are some additional complexities for plans that require completion
of a minimum number of hours as part of the service requirement. Keep in
mind that the hours component may be reviewed based on either actual hours
worked or an equivalency.
Consider a plan with a requirement of one year of service, defined as
completion of 1,000 hours in a 12-month period. With a few very limited
exceptions, this is the maximum service requirement a plan can impose. One
of the first items to identify is the 12-month period used to measure the
hours worked. This is called the eligibility computation period. In this
scenario, an employee's first eligibility computation period always runs
from initial date of hire to the first anniversary date. However, the plan
must specify whether the second and all subsequent eligibility computation
periods shift to the plan year or continue to follow employment anniversary
dates. Let us return to our friend Herbert.
| |
| Date of Hire: |
4/1/12 |
4/1/12 |
| 1st ECP*: |
4/1/12 - 3/31/13 |
4/1/12 - 3/31/13 |
| 2nd ECP*: |
1/1/13 - 12/31/13 |
4/1/13 - 3/31/14 |
| 3rd ECP*: |
1/1/14 - 12/31/14 |
4/1/14 - 3/31/15 |
| *Eligibility Computation Period |
If Herbert does not complete at least 1,000 hours of service by March 31,
2013, his eligibility service will be measured either during the 2013
calendar year or his second employment anniversary year, depending on the
eligibility computation period specified in the plan document, to determine
if he meets the service requirement. Note that when the eligibility
computation period shifts to the plan year, the period from January 1, 2013
through March 31, 2013 is counted in both the first and second eligibility
computation periods; therefore, any hours Herbert works during that time
frame must be included in both eligibility computation periods when
assessing whether he completed the requisite 1,000 hours.
Many employers find the plan-year-shift method to be much easier to
manage since all employees will be tracked during the same 12-month period
(the plan year) after their initial year of employment. For plans that
continue to use anniversary year, employees' hours must be tracked over a
different 12-month period, depending on their dates of hire--a requirement
that can be quite burdensome and time-consuming.
Plans with shorter service requirements can also face challenges when
incorporating an hours-worked component. Recall that the maximum service
requirement allowed by law is 12 months with 1,000 hours. That means a plan
with a service requirement of completion of three months with at least 300
hours would be in violation since an employee could complete 1,000 hours in
a year without ever working 300 hours in three months. Therefore, extreme
caution should be exercised when establishing service requirements of less
than one year that also incorporate hours.
Also, consider a plan that requires completion of six months of service
with at least 500 hours of service. Depending on how the plan document is
written, this provision could impose burdensome recordkeeping requirements.
For example, it may refer to contiguous six-month periods, e.g. January 1st
to June 30th followed by July 1st to December 31st, or it may create rolling
six-month periods, e.g. January 1st to June 30th and February 1st to July
31st, etc.
Regardless of how a plan counts service for eligibility, it is important
to remember that all service dating back to an employee's original hire date
must be considered.
Vesting
While not quite as complex as eligibility, counting service for vesting
has a few noteworthy nuances. Similar to eligibility, the plan must specify
which counting method (elapsed time, actual or equivalency) is to be used
and define the measurement period (vesting computation period) as either the
plan year or anniversary year. Unlike eligibility, however, the vesting
computation period does not shift after the initial year. It is either
always the plan year or always the anniversary year.
For plans defining the vesting computation period as the plan year and
using the actual hours or equivalency methods, new employees effectively
have fewer than 12 months to complete the required hours to earn a year of
vesting service during the initial vesting computation period. When the
vesting computation period is the anniversary year, plan sponsors should be
aware of the same recordkeeping burden as described for eligibility. Namely,
when using actual hours or equivalency, each employee will have a different
tracking period based on his hire date.
There is another very key area in which eligibility and vesting are
different when there is an hours-worked component involved. Let us again
consider a plan that requires completion of 1,000 hours in a 12-month period
to be credited with a year of service. For eligibility, both of these
requirements must be met; an employee must complete both 1,000 hours of
service and 12 months of employment before being credited with a year of
service. An employee who works well over 1,000 hours but terminates
employment after only 11 months does not receive credit.
For vesting, on the other hand, an employee is credited with a year of
service as soon as he or she completes 1,000 hours of service during a
vesting computation period regardless of the number of months worked.
Therefore, it is not at all uncommon for an employee to have received credit
for more years of service for vesting than for eligibility/participation.
This is especially important to remember when determining vesting credit for
an employee who terminates but may have already completed 1,000 hours prior
to termination.
One other important difference is the years that must be counted for
vesting. Although all service from date of hire must be recognized for
eligibility, a plan can be written to ignore years prior to its effective
date (or the effective date of any previous plans) and/or years prior to
attainment of age 18 for vesting purposes.
Other Reasons to Count Service
There are several other provisions that may require counting service.
Examples include
- Allocation requirements, such as completion of a year of service, to
share in allocations of matching or profit sharing contributions for a year,
and
- Definitions of normal retirement using both age and service such as later
of attainment of age 65 or completion of five years of service.
Conclusion
While there is flexibility to count service using any of the methods
described above, plan documents must specify the methods a plan elects to
use. Therefore, it is advisable to review plan documents regularly to ensure
proper understanding and to seek assistance from service providers to
clarify any points of confusion.
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