401k Plan 401k accrual and vesting 401k Rules

Chapter 3: Benefit Accrual and Vesting

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Corporate and Institutional Investors


This chapter describes ERISAs rules for eligibility, benefit accrual and vesting.

These questions are addressed:
Earning Service Credit

Who must be allowed to participate in your employers retirement plan?

What is benefit accrual and how does it work?

What other rights are protected as part of your accrued benefits?

Can your plan reduce future benefits?

What happens to your service credit if you leave your job and later return?

What happens to your benefit accruals (and your benefit payments) if you retire and later go back to work?

What is vesting and how does it work?

May plans use other vesting schedules?

Earning Service Credit

ERISA establishes rules for how employers must measure employees employment service to determine how the eligibility, benefit accrual and vesting rules apply. ERISA generally defines a year of service as 1,000 hours of service during a 12-month period. Different rules apply to counting service for purposes of eligibility, benefit accrual and vesting.

A plan basically has a choice among three methods for determining whether you must be credited with a year of service for participation, vesting and, in some circumstances, benefit accrual: the general method of counting service, a simplified equivalency method, or the elapsed time method. Refer to your summary plan description to see which method is used by your plan.

Who must be allowed to participate in your employers retirement plan?

Generally speaking, if your employer provides a plan that covers your position, you must be permitted to become a participant if you have reached age 21 and have completed 1 year of service. Even if you work part time or seasonally, you cannot be excluded from the plan on the grounds of age or service if you meet this service standard. You must be permitted to begin to participate in the plan no later than the start of the next plan year or 6 months after meeting the requirements of membership, whichever is earlier. You should be aware, however, that your employer may provide one or more plans covering different groups of employees or may exclude certain categories of employees from coverage under any plan. For example, your employer may sponsor one plan for salaried employees and another for union employees, or you may not be within the group that the employer defines as covered by a plan.

ERISA imposes certain other participation rules. They depend on the type of employer for whom you work, the type of plan your employer provides, and your age. For example:

If you were an older worker when you were hired, you cannot be excluded from participating in the plan on the grounds of age just because you are close to retirement.

If upon your entry into the plan, your benefit will be immediately fully vested, or non-forfeitable, the plan can require that you complete 2 years of service before you become eligible to participate in the plan. 401k plans, however, cannot require you to complete more than 1 year of service before you become eligible to participate.

If you work for a tax-exempt educational institution and your plan benefit becomes vested after you earn 1 year of service, the plan can require that you be at least age 26 (instead of age 21) before you can participate in the plan.

If your employer maintains a SEP, you must be permitted to participate if you have performed services for the employer in 3 of the immediately preceding 5 years.

What is benefit accrual and how does it work?

When you participate in a retirement plan, you accrue (earn) benefits. Your accrued benefit is the amount of benefit that has accumulated or been allocated in your name under the plan as of a particular point in time. ERISA generally does not set benefit levels or specify precisely how benefits are to accumulate.

Plans may use any definition of service for purposes of benefit accrual as long as the definition is applied on a reasonable and consistent basis. Service for purposes of benefit accrual generally takes into account only the years of service you earn after you become a plan participant, not all service you may perform since you were hired by your employer. Employees who work less than full-time, but at least 1,000 hours per year, must be credited with a pro rata portion of the benefit that they would accrue if they were employed full time.

To illustrate: If a plan requires 2,000 hours of service for full benefit accrual, then a participant who works 1,000 hours must be credited with at least 50 percent of the full benefit accrual.

A special rule applies to SEPs: all participants who earn at least $450* (in 2003) in compensation from their employers are entitled to receive a contribution or, if the SEP is a salary reduction SEP, to elect to make a contribution.

Since ERISA generally does not regulate the amount of your benefit, you can estimate how much you are building up only by examining the summary plan description or the plan document. These documents should explain how you earn service credit for full benefit accrual each plan year.

What other rights are protected as part of your accrued benefits?

Your accrued benefit includes more than just the amount of benefit you have accumulated. Your plan provides you with various rights and options, some of which are protected rights attached to your benefit amount. As a general rule, protected rights cannot be reduced or eliminated, nor can they be granted or denied at your employers discretion. If a plan feature you care about has been eliminated, this section is designed to help you determine if it was protected or not.

The rights that are protected include:

Early retirement benefit. ERISA does not require a retirement plan to provide participants with the option to retire earlier than at the plans normal retirement age. If such an option is offered, however, a plan generally may not be amended to eliminate the right to take such an early retirement with respect to benefits accrued before the amendment.

Retirement-type subsidy. Retirement-type subsidies are also a protected part of your benefit and cannot be eliminated retroactively.

Certain important plan features are not protected, such as a social security supplement, directing investments, a particular form of investment, taking a loan from a plan, or making employee contributions at a particular rate on either a before-tax or after-tax basis.

Can your plan reduce future benefits?

ERISA does not prohibit your employer from amending the plan to reduce the rate at which benefits accrue in the future. For example, a plan that paid $5 in monthly benefits at age 65 for years of service up through 2002, may be amended to provide that years of service beginning in 2003 are credited at the rate of $4 per month.

If you are a participant in a defined benefit plan or a money purchase plan, you must receive written notice of a significant reduction in the rate of future benefit accruals after the plan amendment is adopted and at least 15 days before the effective date of the plan amendment. The written notice must describe the plan amendment and its effective date.

What happens to your service credit if you leave your job and later return?

A break in service can have serious consequences for your benefit if it extends for a long enough time and your benefit is not yet fully vested. However, ERISA does not permit your accrued benefit to be forfeited if you have a short break in service. ERISA establishes rules governing the circumstances under which a plan is required to continue to credit a participant with service earned before a break in service if the participant later returns to employment. These rules are very technical, but in general guarantee your service credit cannot be forfeited for absences shorter than 5 consecutive years. If you need to take a leave of absence, you should carefully examine your plans rules so that you do not inadvertently and unnecessarily lose retirement benefits you have accrued.

What happens to your benefit accruals (and your benefit payments) if you retire and later go back to work?

If you continue to work past normal retirement age (without retiring), you continue to accrue benefits, regardless of age. However, a plan can limit the total number of years of service that will be taken into account for benefit accrual for anyone in the plan. If you retire and later go back to work with your employer, you must be allowed to continue to accrue additional benefits, subject to any such limit on total years of service credited under the plan.

Plans that provide for the payment of early retirement benefits may suspend payment of those benefits if you are reemployed before reaching normal retirement age. However, if the plan suspends payment of benefits before normal retirement age, under circumstances that would not have permitted a suspension after normal retirement age, and the plan pays an actuarially reduced early retirement benefit, the plan must actuarially recalculate your monthly payment when you begin again to receive payments.

Under certain circumstances (described below), your benefit payments after you reach normal retirement age may be suspended if you return to work. For example, ERISA permits a multiemployer plan to suspend the payment of normal retirement benefits if you return to work in the same industry, the same trade, and the same geographical area covered by the plan as when benefits commenced.

Before suspending benefit payments, however, the plan must notify you of the suspension during the first calendar month in which the plan withholds payments. The notification must give you the information on why benefit payments are suspended, a general summary and a copy of the plans suspension of benefit provisions, a statement regarding the Department of Labor regulations, and information on the plans procedure under which you may request a review of the decision to suspend benefit payments. If most of this information is contained in the plans summary plan description, the notification may simply refer to the appropriate pages of the summary plan description.

A plan that suspends benefit payments must advise you of its procedures for requesting an advance determination of whether a particular type of reemployment would result in a suspension of benefit payments. If you are a retiree and are considering taking a job, you may wish to write to the administrator of your plan to ask if your benefit payments would be suspended.

What is vesting and how does it work?

Vesting refers to the amount of time you must work before earning a non-forfeitable right to your accrued benefit. When you are fully vested, your accrued benefit will be yours, even if you leave the company before reaching retirement age. Generally, if you are employed when you reach your plans normal retirement age (usually 65), you will be fully vested. You also must be permitted to earn a vested right to your accrued benefit through service as described below.

You are always entitled to 100 percent vesting in your own contributions and salary reduction contributions and their investment earnings. However, if your employer contributes to your accrued benefit (as most do), you may be required to complete a certain number of years of service with the employer before the employer portion of your accrued benefit becomes vested. Thus, if you terminate employment before working for a long enough period with your employer, you may forfeit all or part of your accrued benefit provided by your employer.

ERISA sets these standards as a minimum for counting vesting service. Plans may provide a different standard, as long it is more generous than these minimums. Check your summary plan description for a description of your employers vesting schedule.

Prior to 2002, the vesting scheduled your employer used must have been at least as generous as one of the two following schedule.

7-Year "Graded" Vesting Schedule
Years of Vesting Service Completed Percentage of Accrued Benefit Vested
Less than 3 0%
At least 3 but less than 4 20%
At least 4 but less than 5 40%
At least 5 but less than 6 60%
At least 6 but less than 7 80%
At least 7 100%
Years of Vesting Service Completed Percentage of Accrued Benefit Vested
Less than 5 0%
At least 5 100%

With some exceptions, once you begin participating in a retirement plan, all of your years of service with the employer maintaining the plan after you reached age 18 must be taken into account to determine whether and the extent to which your accrued benefits are vested, including service you earned before you began to participate in the plan and service you earned before the effective date of ERISA.

However, ERISA does allow plans to disregard certain periods for purposes of determining an employees vesting service. If you wish further details on what periods of service may be disregarded, see your summary plan description or the plan document to find out what periods are counted in your plan.

When you receive a benefit statement, compare the amount of your accrued benefit with the amount or percentage of your vested benefit to determine its accuracy. If these items are not clear from your benefit statement, ask your plan administrator. The plan administrator may send you a benefit statement each year. If not, you may request a copy. In order to keep track of your vesting service, you may want to keep records of your hire date, the date you began participating in the plan, and the dates of any leaves of absence that could affect your total service.

If the plans vesting schedule is changed after you have completed at least 3 years of service, you have the right to select the vesting schedule that existed prior to the change for the entire length of your service, rather than the new schedule.

In 2002, changes to the vesting rules speeded up the minimum vesting schedules for employer matching contributions. There are now two alternative minimum vesting schedules that a plan may use.

Under the first minimum vesting schedule (cliff vesting), the time period for acquiring a non-forfeitable right in employer matching contributions was shortened from 5 years to 3. This allows employees with 3 years of service to be 100 percent vested in the employers matching contributions.

The second minimum vesting schedule (graded vesting) was shortened by 1 year, from 7 years of service to 6. A participant has a 20-percent non-forfeitable right in the employer matching contributions upon completion of 2 years of service. The percentage of the non-forfeitable right increases by 20 percent upon completion of each additional year of service until the participant has a non-forfeitable right in 100 percent of the employer matching contributions.

Following is the new graded minimum vesting schedule for employer matching contributions:

Years of Vesting Service The non-forfeitable Percentage
2 20%
3 40%
4 60%
5 80%
6 100%
May plans use other vesting schedules?

Top-heavy plans must have a faster vesting schedule. Plans are considered top-heavy if they are tax-qualified and more than 60 percent of the benefits accrue to certain owners and officers, otherwise known as key employees. This could occur, for example, in small companies that have frequent turnover of rank-and-file workers. In years in which a plan is top heavy, you have the right to both faster vesting and minimum benefits, if you are not a key employee.

All benefits under a SEP and a SIMPLE plan must be fully vested at all times.

Source: Department of Labor