Plan sponsors have several variables when creating their plan document, including:
- At inception of the plan, you can select 'amnesty' - this means everyone is eligible to for the plan if they are working on the amnesty date (regardless of years worked or hours in the current year)
- Eligibility time period (such as 6 months or a year)
- Elapsed time versus hours (for use during the eligibility time period)
- Entry Date once eligibility is met (as in when can they enter the plan, such as immediate upon reaching eligibility or the first day of the next month, or first day of the next plan quarter, or semi- annual, etc.). Wording in your plan document is crucial here as there is a significant difference between "next following" or "coincident with".
The eligibility and entry determination process can get tricky. Another important component in this discussion, is our industry likes to use the phrase 'once eligible always eligible unless the participant has experienced five consecutive one year breaks in service'. This works most of the time (but not all of the time).
This FAQ is a high level overview and is not intended to cover all scenario's nor should you use this site for determining eligibility and entry dates. If in doubt, call your consultant!
How do we determine when a participant can start salary deferrals or be eligible for a profit sharing contribution?
Eligibility criteria can be different for the account sources (401(k) or profit sharing). Some plans have immediate eligibility for the 401(k) and a one year of service requirement for the profit sharing contribution.
It is also important to note, that eligibility and entry date for the profit sharing contribution does not necessarily mean the participant qualifies for the profit sharing contribution! Hence for determining if someone is eligible to receive a profit sharing contribution, we have a three step criteria:
- Step 1: Have they met the eligibility requirements?
- Step 2: Have they met entry date requirements?
- Step 3: Have they met the profit sharing plan requirements (such as a 1,000 hours in the plan year and last day requirement)
For the 401(k) component, the participant must meet the eligibility and entry date requirements.
Review of Step 1: Have they met the eligibility requirements?
The plan sponsor can use two methodologies:
- Elapsed Time
The elapsed time methodology is the easiest. The eligibility period starts with the employment commencement date (ECD). Once the employee's length of service equals the plan documents prescribed 'period of service', they have met the eligibility requirement. For a plan with a one year period of service eligibility requirement, the employee has met the eligibility requirement at the close of business on April 14th (if they are employed on that day).
The hours methodology requires the plan to track hours. The two key review criteria for hours methodology are the ECD and the computation period (the consecutive month period established in the plan document). For plans with a one year criteria (12 month) and 1,000 hours, the eligibility computation period is 365 days (non leap year). If a participant starts on April 15th (the ECD), the eligibility computation period runs through April 14th of the next year. The participant meets the eligibility criteria at the close of business on April 14th if they have worked 1,000 hours in the eligibility computation period (notice we did not say employed on that date, as they may have met the 1,000 hours before that, left the firm and rehired after the computation period). Please note, in this example the participant has not met the eligibility criteria when they reach 1,000 hours!
If the participant does not meet the eligibility criteria in the first review period, the second review period is dictated by the plan document. The options are to change to a plan year review or continue using anniversary periods. Most plans use the change to a plan year review. In the above example using the change to a plan year for the next computation period, assuming an April 15th, 2008 ECD, the first review period is April 15th, 2008 - April 14th, 2009. The next period of review is the 2009 plan year. If the employee did not meet the first computation period and met the second computation period of January 1, 2009 - December 31, 2009 (1,000 hours), they have met the eligibility criteria as of the close of business on December 31, 2009.
Review of Step 2: Have they met entry date requirements?
Entry date is the easier of the two steps! Now that you know how to calculate eligibility and the date they satisfy eligibility, simply review the plan document for the entry date. The most common entry date for profit sharing components is a semi-annual entry date (January 1st or July 1st). In the above example, if an employee meets eligibility on April 14th, they can enter the plan on the next July 1st. If the employee meets the eligibility criteria on December 31st, they can enter the plan on the next January 1st.
What is the entry date for the first of year hires (or January 2nd, since January 1st is a holiday) that use semi-annual entry dates?
As indicated above, entry date is defined in the plan document. Lets use an eligibility criteria of one year with a 1,000 hour requirement. If a participant is hired on January 1, 2008; they will meet the eligibility criteria at the end of the business day on December 31st (assuming 1,000 hours worked). They can enter the plan on January 1, 2009.
Since January 1st is a holiday, many companies have a January 2nd hire date. Using the same scenario as above, the participant completes their eligibility requirement at the end of business on January 1st, therefore they enter the plan on the next July 1st. This is why some companies use January 1st as the employment commencement date.
The content of this website is general in nature and is for informational purposes only. It should not be used as a substitute for specific tax, legal and/or financial advice that considers all relevant facts and circumstances.