Legal Blog

Don’t Fall Into the 401(k) Exclusion Classification Trap

With pressure on employers to cut costs, some employers have asked if they can amend their 401(k) plan to exclude participation by part-time employees.  The short answer is, “No.”  But there are ways that an employer can restrict participation in its pension plan.

Under the Internal Revenue Code, an employer is prohibited from including a blanket exclusion of part-time employees from participation.  The tax code provides certain minimum participation requirements for a plan to maintain its qualified status and continue to enjoy tax benefits.  One requirement is that a plan cannot require an employee to complete more than one “year of service” with an employer before becoming eligible.  A “year of service” is defined as a 12-month period during which an employee does not work 1,000 or more hours (or a lower number of hours selected by the plan sponsor).

A blanket exclusion of “part-time” employees, a service-based exclusion classification, is banned because it could keep out employees who work at least 1,000 hours during a 12-month period.  Thus, under IRS guidance, such a service-based classification exclusion is prohibited.

But there is a way an employer can legally restrict pension plan participation.  If the plan excludes employees based on their job classification rather than service hours, IRS guidance indicates that the plan should not be challenged on IRS examination or audit.  In fact, the specific example given in the guidance is an exclusion of Hourly Paid Employees.  Hourly Paid Employees are employees that receive an hourly wage for their employment services.  Because this exclusion is based on job classification rather than a service requirement (such as, 20 hours per week or more than 5 months) that may violate the law’s service requirement, it should pass muster.

As part of my practice, I advise companies, their pension plans and their plan trustees on ERISA and related legal matters.  If you have a question, call me.


Questions about 401(k) plans? Please contact us.




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