May a 401(k) plan validly exclude part-time employees?

May a 401(k) plan validly exclude part-time employees? What effect does the minimum service crediting have on this issue if full-time employees are eligible for the plan after one full month of service?

There are two issues here, minimum service requirements and the ability to exclude employees by category. As to minimum service, the most uou can require is one year/1000 hours for participation in a k plan. If the plan passes the coverage teste in 410(B) (including the nodiscriminatory classification test/average benefits percentage test), then the part timers can be excluded as a group. The demographics of the part time group are going to determine this, including how part time they are, what the turnover in the part time group is like, etc. In this sort of situation, you also have to kep your eyes open for leased employee issues and indepndent contractors who may be employees, since they can affect the numbers.

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I tend to disagree. Even if the plan does or would pass coverage with an exclusion of "part timers", it is not a valid exclusion. A classification of exclusion cannot relate to age or service. The only method of excluding part timers is to initiate a 1000 hour requirement. I had a client that excluded part time employees in their document who was recently fined by the IRS.

I agree with JMLSON. See IRS Field Directive released November 22, 1994 (21 BPR 2221).

There is an example (somewhere) in the Section 410 regulations that expressly states that you cannot exclude part-time employees as a class.

To follow up on Kirk's comment, see Reg. 1.410(a)-3(e)(2), Example (2).

I agree that the 1000 hours requirement is the only way to exclude P/T employees, but

what about a less than 12 month wait for

eligibility? I have been told from many sources that if your Plan has less than a 12 month wait, you lose the right to exclude P/T

employees. Any comment?

You can institute an hourly requirement if your elgibility requirement is less than 12 months. The hourly requirement must be prorated and at the same time not violate the minimum eligiblity standards of 1000 hours. If they don't want to use the Elapsed Time method because they want to exclude as many "part timers" as possible, it is best to design the document in this fashion: "age 21 and completion of one of the following service requirements: 1) a total of three calendar months in which at least 100 hours of service is credit in each month OR 2)one year and 1,000 hours". This way a part time employee could work 80 hours per month and still be excluded, but full time employees could come into the plan in 3 months.

I don't believe criterion (1) in the preceding message works. You can't have 3 months of service with an hours requirement.

I've seen it, Wessex (strange but true dept.) -- the New England (Life Ins. Co.) prototype does it. The document requires at least 83-1/3 hours of service in order for an individual to earn one "Month of Service," and the employer can fill in any number of months desired -- one through 11 is perfectly OK. But it also has a "provided that" provision ... "provided that in no event shall an employee be required to wait longer than one Year of Service, defined as a 12-month period during which he or she works at least 1,000 hours of service" (I'm not really quoting here, but that's the gist of it.)

Seems awfully complicated to me. So most prototypes seems to just throw in the towel and say to sponsoring employers that no hours-per-month or other hours requirement can be applied if the employer isn't using a full one Year of Service waiting period.

Are the 1000hrs. a requirement of the IRC only? Is it also an ERISA requirement? I need to determine whether a plan not qualified under the IRC can exclude part time employees.

There is a parallel 1,000 hour rule in ERISA:

http://www4.law.cornell.edu/uscode/29/1052.html

It seems to be the same in all material respects as the 1,000 hour rule in section 410(a) of the Code:

http://www4.law.cornell.edu/uscode/26/410.html

Boy, the more you read these provisions the more of a stretch the IRS' position seems to me to be. They don't literally say that the only age and service rules a plan can apply are the age 21/1,000 hour of service rules ... they say that an employee can't be made to wait to enter a plan any longer than certain entry dates that follow age 21 and 1 year of service. They don't address minimum coverage requirements for a plan as a whole (whether classes of employees can be excluded even though those age and service requirements might be met). Classes can be excluded, of course, if the plan as a whole meets the minimum coverage rules of section 410(B) of the Code.

Arguably part-timers are a "class" that can be excluded ... not because they haven't met the 1 year-of-service rule (some will, if they work more than about 20 hours per week for a while), but because their current RATE of service is not at a certain pace (e.g. at least 30 hours per week).

The IRS' position makes sense if it's right that classifying people based on their current rate of performing service is a "service"-related restriction and if the age/21 and 1 year-of-service rules are the ONLY age and "service" requirements allowed by law.

But that interpretation of the 410(a) "service" requirement does not seem compelling to me ... one could just as easily argue that whether one works for a particular division of the employer is a "service"-based classification (who are you providing service for?) and yet such a service requirement is of course permitted if the plan as a whole is still able to meet the minimum coverage rules of section 410(B).

The IRS seems to figure that 410(a) restricts "how much" service a plan can require - whether in terms of duration OR RATE of service - but that it does not restrict "what kind" of service one can require, such as service for a particular division or subsidiary whose employees are covered by the plan.

[This message has been edited by Dave Baker (edited 10-24-1999).]

I think the IRS position makes sense (slap me quick!) under another of their principles, which is that the employer can't be arbitrary in establishing excluded employees- in other words it can't "name" individuals who are excluded.

The problem with a "part-time" classification is that it is inherently arbitrary. When an employee initially comes to work, the employer often has no idea what his or her "regular" hours will be, so the human resources department or whatever guesses and puts the employee in the full-time or part-time category. Full-time employees may be part-time and vice versa when you actually total up their hours, but they will often remain there despite variations in their schedules over their working career.

What about your category of employees who work at the "rate" of 30 hours a week? What happens if things are slow and an employee only gets 25 hours? Do you kick him out of the covered class? What if this continues for a year? It works the other way too. An employee may be hired "part-time" but he has skills that result in his or her working an average of 35 hours a week (this is all too common for part-time deals).

The problem is that the part-time classification isn't a real job category - its too arbitrary - plus you have an objective standard as an alternative - 1000 hours in a 12 month period.

Responding to one comment by Dowist, as far as I know one can enumerate the employees by name who are eligible to participate. One would have to pass the ratio percentage test because it would flunk the reasonable classification part of the nondiscriminatory classification test.

I've seen one law firm plan that listed employees by name and received a determination letter.

You're right about the determination letter. The fact that one employer received a favorable letter provides little evidence that it was valid. I shouldn't have even mentioned it but thought it relevant that I'd at least seen it once in practice.

Dowist, let us know if you find anything else to support your comment #2 above. Otherwise, if the nondiscriminatory classification test regulation says we can't enumerate employees by name, it implies to me that it's all right for plans that satisfy 410(B) through the ratio percentage test. Maybe the IRS has an informal position against listing employees by name that can't be detected through regulations, notices, etc.

Of course we are all talking about part-timers, but the document CAN exclude "hourly" employees. This is a permissive class to exclude. Of course, you must still pass coverage testing etc.., but I am aware that many documents inc Corbel's Volume Submiter and most nonstandardized prototypes allow for the exlusion of hourly employees, most of whom are generally part time.

I've seen, and written plans that are worded: Employees hired who are regularly scheduled to work full time must meet a 3 month (or whatever) eligibility service requirement; all other employees must meet 12/1000. The IRS lets this through all the time. I see the IRS' position as inherently untenable. What is the point of the service requirement? Its to allow otherwise eligible employees to enter the plan in a reasonable period of time. It does not define what an otherwise eligible employee is. That is the coverage issue. It would be legitimate to draft a plan that includes only blondes with blue eyes, PROVIDED the coverage test were met. It is permissable to exclude by name, or other classification, and I see nowhere in the code or regs a requirement that the classification be reasonable. Its a numbers game, and if the numbers work, they work. Philosophically, the IRS' position makes no sense.

1. Being respectful to the IRS and the IRS determination letter program, the fact that a particular provision in a plan got through the determination letter process without being questioned does not mean that the IRS or the Code approves that particular provision as a policy matter - it protects that plan, but all that shows is that the agent that reviewed the plan either didn't have a problem with it, or more likely he or she didn't identify the problem.

Even then, I would not feel comfortable with an aggressive position - such as the exclusion of part-time employees - unless the position was highlighted to the agent and you knew the agent had reviewed the issue. A determination letter is only so good as the disclosure that is given to the agent reviewing the plan.

2. I don't think you can exclude individuals by naming them. I don't recall any formal ruling on this (although I think there is something), but you might want to look at Reg. ss 1.410(B)-4(B), which describes accepatable classifications for the average benefit coverage test:

"A classification is established by the employer in accordance with this paragraph . . . if and only if, based on all the facts and circumstances, the classification is reasonable and is established under objective business criteria that identify the category of employees who benefit under the plan. Reasonable classifications generally include specified job categories (i.e., salaried or hourly), geographic location, and similar bona fide business criteria. An enumeration of employees by name or other specific criteria having substantially the same effect as enumeration by name is not considered a reasonable classification."

Now this is a requrirement for the average benefit test only, and you could argue that you don't have to have a "reasonable" classification for the ratio test, but I think that "reasonableness" is a requirement for any exclusion.

3. Finally, you will never convince me that a classification of part-time, temporary, seasonal, etc. is anything but arbitrary and inherently susceptible to abuse. This is the reason you have the 1000 hour standard. I think the IRS agrees with me.

I've actually seen the dual service requirement in prototype plan documents, as well as volume submitter documents established by law firms in the Cleveland Ohio area. Never seen the IRS squirm on that one.... In fact, I've had them suggest it, and have even had an agent agree to its inclusion in the coverage section of a prototype (excluding p-t employees with less than 12/1000) in order to eliminate immediate participation by p-t employees.

As far as the name exclusion, well, I wouldn't do it for any group, but do it all the time for HCEs (especially in the bad old days of family aggregation...). Why is it that excluding workers at plant b or in a geographical location is reasonable, but excluding them on the basis of hour worked isn't? It's a philosophical inconsistency. If the "exclusion" of employees is in fact legitimate, why are various classifications of employees arbitrary, when others are not? It seems to be a perfectly legitimate distinction (and valid business rationale exists) in the health and welfare arena....

In support of MoJo's comments, we have also consistently gotten approval letters with the dual standards. The language was specifically brought to the attention of the reviewer, in some cases as a change to volume submitter language, and in some cases as a proposed remedial amendment in direct response to a deficiency letter where the plan as initially submitted simply excluded part-timers.

[This message has been edited by mo (edited 10-27-1999).]

the erisa outline book states that you can exclude hourly paid workers as a class. perhaps that would be a way to exclude the part-timers.

The IRS will issue determination letters to plan which exclude from participation part-time employees (provided, however, that once they have completed 1,000 hours in any plan year, they must be eligible to participate in the plan). Consequently, the conversations above all should be read together to illustrate that yes part-time employees can be excluded, as long as you satisfy and monitor the 1,000 hours of service requirement. My client base (tech. clients who want explicit exclusions to fit their varying employee base) usually always request this exclusion, and I can think of at least 10 individually designed plans that have all received letters after significant IRS review.