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Excluding Part-Timers from 401(k) Eligibility401(k) Plans

Question: We would like to amend our 401(k) plan to exclude all part-time employees from plan eligibility. Our plan requires an employee to complete 1,000 hours of service in a 12-month period before becoming eligible to participate in the plan, but we want to exclude part-time employees regardless of their hours. Can we do this?

Answer: The short answer is no, if you intend to exclude part-time employees based on their job classification as part-time, not their actual hours. Here’s why.

The 1,000-hour service rule currently in your plan is generally the longest waiting period the Internal Revenue Code allows. In other words, the Code does not allow a plan to have a service-based eligibility threshold requiring more than 1,000 hours of service.

Since many part-time employees will never complete 1,000 hours of service in a 12-month period, your plan probably excludes many of them. Your question indicates you would like to go a step further, though, and exclude all part-time employees regardless of their actual service.

If your company is like many employers, part-time status may be based on anticipated or scheduled service, instead of actual service. While that may seem different from the Code’s 1,000-hour rule, in the view of the IRS, a service-based eligibility threshold which does not count actual hours of service will fail the 1,000-hour rule if, in operation, it excludes employees whose actual service satisfies the Code’s 1,000-hour minimum requirement.

For example, if your plan were to define part-time employees as employees who are “regularly scheduled” to work 20 or fewer hours a week, the plan might end up excluding employees who actually work 20 hours a week for 52 weeks and therefore have 1,040 hours of service for the year. In this event, your plan would be using a service-based threshold to exclude employees who in fact have satisfied the Code’s 1,000-hour minimum service rule.

One approach to excluding employees who are not full-time is to look for a common denominator among the employees you wish to exclude — such as job function or job location — which is not service-based.

For example, if most of your part-time employees are performing the same job function or work at the same location and you are willing to exclude all of your other employees who perform the same job function or work at the same location, you may be able to craft a rule excluding those part-time employees without violating the Code’s minimum service rule.

Be careful, though, because at least one IRS representative has indicated even criteria which are not service-based may violate the Code if they merely disguise an improper service rule. You also want to ensure excluding a group of employees will not cause your plan to fail the Code’s minimum coverage requirements.

Finally, we note errors in applying the eligibility rules to part-time employees frequently turn up in voluntary compliance and IRS audits. It is critical to have the plan’s terms clearly state your company’s design choices, especially when excluding certain classes of employees.

Moreover, you should routinely review plan language to ensure it reflects changing employment practices.


Can’t Find a Participant or Beneficiary

Question: From time to time, our 401(k) plan is required to make minimum distributions under Internal Revenue Code Section 401(a)(9) to participants who have no valid address on file. We also experience problems locating beneficiaries when a participant dies. What procedures should we follow when the plan is required to make a distribution but we cannot locate the participant or beneficiary?

Answer: ERISA’s fiduciary duty rules require plan sponsors and administrators to make reasonable efforts to locate missing participants and beneficiaries. The U.S. Department of Labor (DOL) has issued specific guidance on handling missing or unresponsive participants in terminating plans but hasn’t provided similar guidance for ongoing plans. Based on the DOL guidance for terminating plans, consider the following procedures.

Search Methods for Terminating Plans.DOL guidance states if a participant or beneficiary cannot be located using first-class mail or electronic notification, or if the fiduciary has reason to believe the address on file is wrong, the fiduciary must take these additional steps:

  1. Use certified mail;
  2. Check related plan records, such as the employer’s group health plan, for a more current address (and to avoid HIPAA privacy concerns, request a health plan fiduciary to contact or forward a letter to the participant or beneficiary);
  3. Check with the participant’s designated beneficiaries; and
  4. Use the Social Security Administration letter-forwarding service. IRS guidance, in the context of correcting plan errors, also suggests using the certified mail and Social Security letter-forwarding methods to locate participants. (Although the DOL guidance also suggests using the IRS letter-forwarding service, the IRS service is no longer available for locating missing participants (see our article)). Expenses incurred using these methods can be charged to the participant’s account if the expenses are reasonable, the plan so permits, and the charge is consistent with the plan fiduciary’s ERISA duties.

Other Search Methods. Both DOL and IRS guidance discuss other search options to consider, including Internet searches, commercial locator services, and credit-reporting agencies. If the cost of an alternative search option would be charged to a participant’s account, the size of a participant’s account in relation to the cost of the search must be considered when deciding whether that alternative is appropriate.

When Search Efforts Fail. Check your plan document to see if it addresses missing or unresponsive participants. Some plans describe how plan fiduciaries must handle account balances when search efforts fail; other plans authorize plan administrative committees to adopt a policy for handling that situation.

Some plan provisions or policies direct the plan fiduciary to allocate the funds in the missing participant or beneficiary’s account among the accounts of the remaining participants, subject to restoration if the missing individual should reappear. Even though this allocation mimics a forfeiture, IRS regulations provide that it is not an impermissible forfeiture, so long as the plan is obligated to restore the missing individual’s account balance.

No Fiduciary Safe Harbor for Distributions. The DOL provides a safe harbor which allows plan fiduciaries to make distributions to IRAs on behalf of participants (including beneficiaries) who fail to make distribution elections upon a plan termination or for small “cash-out” distributions under the automatic rollover rules (generally amounts that exceed $1,000 but — ignoring rollover balances — do not exceed $5,000).

Unfortunately, there is no fiduciary safe harbor for making mandatory distributions from an ongoing plan when the account does not qualify for an automatic rollover. We recommend that you seek experienced benefits counsel before implementing any distribution program in these circumstances.


Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.