One of the most
fundamental requirements in managing a qualified retirement plan is
counting an employee's length of service. It is the basis for
determining such items as plan eligibility, entitlement to company
contributions, vesting and even retirement itself. Although this seems
like a straightforward task, the rules are quite complex and create
traps for the unwary.
Methods of Counting Service
Before reviewing the reasons for counting service, it is important
to understand the methods available for doing so. There are several
and each has certain advantages and disadvantages depending on how a
plan sponsor runs its business.
Elapsed Time Method
The elapsed time method credits an employee for a period of service
if he is still employed at the end of that period. For example, if
Herbert is hired on April 1, 2012, he receives credit for a year of
service if still employed on March 31, 2013. Credit is given
regardless of the number of hours Herbert works even if he terminates
employment and is rehired prior to March 31, 2013.
One of the advantages of the elapsed time method is that it is not
necessary to keep track of actual hours worked. One of the potential
disadvantages is that employees who work only limited hours may still
be credited with service they would not earn under one of the other
methods, entitling them to the same level of benefits as a full-time
employee. However, for plan sponsors who seek to benefit all employees
equally, this could also be considered an advantage.
Actual Hours Method
The actual hours method considers the hours that each employee
works and/or is entitled to payment, e.g. vacation, sick leave, jury
duty, etc. An employee is required to complete a specified number of
hours in a period to receive credit for that period. A common example
is to require completion of 1,000 hours of service within a 12-month
period in order to be credited with one year of service.
Unlike elapsed time, this method requires employers to keep and
review records of the actual time each employee works. For hourly-paid
employees, records are already available, so there would be minimal
additional recordkeeping. For salaried employees, the actual hours
method will likely impose added recordkeeping. One of the advantages
of this method is that it requires all employees to work the same
minimum hours of service to be entitled to the same level of benefit
under the plan.
This method is a hybrid of the first two. It credits employees with
a certain number of hours for each period they work as follows:
10 hours per day
45 hours per week
95 hours per semi-monthly pay period
190 hours per month
For a plan that uses the monthly equivalency, an employee who
performs any service in a month is treated as working 190 hours during
that month. If the plan credits a year of service as described above,
i.e. 1,000 hours in a 12-month period, an employee would need to
perform at least one hour of service in at least six out of the 12
months (6 months x 190 hours per month = 1,140 hours) to earn a year
The equivalency method has the advantage of requiring continuous
service while minimizing additional recordkeeping requirements;
however, similar to the elapsed time method, it can still have the
effect of crediting very limited time employees with the same benefits
as full-time workers.
Reasons for Counting Service
Now that we have reviewed the methods, it is time to cover some of
the reasons why properly counting service matters.
Initial Plan Eligibility
Many plans require employees to satisfy certain age and/or service
requirements to become eligible. If there is a service requirement,
the plan must specify how to determine when an employee has satisfied
it. In plans that use the elapsed time method for eligibility,
measuring the service requirement can be straightforward. For example,
if a plan requires employees to complete six months of service to be
eligible, any employee who remains employed six months after his hire
date has satisfied the service requirement as of that date. Similarly,
if the plan requires completion of one year of service, employees
satisfy the requirement if they are still employed a year after they
There are some additional complexities for plans that require
completion of a minimum number of hours as part of the service
requirement. Keep in mind that the hours component may be reviewed
based on either actual hours worked or an equivalency.
Consider a plan with a requirement of one year of service, defined
as completion of 1,000 hours in a 12-month period. With a few very
limited exceptions, this is the maximum service requirement a plan can
impose. One of the first items to identify is the 12-month period used
to measure the hours worked. This is called the eligibility
computation period. In this scenario, an employee's first eligibility
computation period always runs from initial date of hire to the first
anniversary date. However, the plan must specify whether the second
and all subsequent eligibility computation periods shift to the plan
year or continue to follow employment anniversary dates. Let us return
to our friend Herbert.
Shift to Plan Year
Date of Hire:
4/1/12 - 3/31/13
4/1/12 - 3/31/13
1/1/13 - 12/31/13
4/1/13 - 3/31/14
1/1/14 - 12/31/14
4/1/14 - 3/31/15
*Eligibility Computation Period
If Herbert does not complete at least 1,000 hours of service by
March 31, 2013, his eligibility service will be measured either during
the 2013 calendar year or his second employment anniversary year,
depending on the eligibility computation period specified in the plan
document, to determine if he meets the service requirement. Note that
when the eligibility computation period shifts to the plan year, the
period from January 1, 2013 through March 31, 2013 is counted in both
the first and second eligibility computation periods; therefore, any
hours Herbert works during that time frame must be included in both
eligibility computation periods when assessing whether he completed
the requisite 1,000 hours.
Many employers find the plan-year-shift method to be much easier to
manage since all employees will be tracked during the same 12-month
period (the plan year) after their initial year of employment. For
plans that continue to use anniversary year, employees' hours must be
tracked over a different 12-month period, depending on their dates of
hire--a requirement that can be quite burdensome and time-consuming.
Plans with shorter service requirements can also face challenges
when incorporating an hours-worked component. Recall that the maximum
service requirement allowed by law is 12 months with 1,000 hours. That
means a plan with a service requirement of completion of three months
with at least 300 hours would be in violation since an employee could
complete 1,000 hours in a year without ever working 300 hours in three
months. Therefore, extreme caution should be exercised when
establishing service requirements of less than one year that also
Also, consider a plan that requires completion of six months of
service with at least 500 hours of service. Depending on how the plan
document is written, this provision could impose burdensome
recordkeeping requirements. For example, it may refer to contiguous
six-month periods, e.g. January 1st to June 30th followed by July 1st
to December 31st, or it may create rolling six-month periods, e.g.
January 1st to June 30th and February 1st to July 31st, etc.
Regardless of how a plan counts service for eligibility, it is
important to remember that all service dating back to an employee's
original hire date must be considered.
While not quite as complex as eligibility, counting service for
vesting has a few noteworthy nuances. Similar to eligibility, the plan
must specify which counting method (elapsed time, actual or
equivalency) is to be used and define the measurement period (vesting
computation period) as either the plan year or anniversary year.
Unlike eligibility, however, the vesting computation period does not
shift after the initial year. It is either always the plan year or
always the anniversary year.
For plans defining the vesting computation period as the plan year
and using the actual hours or equivalency methods, new employees
effectively have fewer than 12 months to complete the required hours
to earn a year of vesting service during the initial vesting
computation period. When the vesting computation period is the
anniversary year, plan sponsors should be aware of the same
recordkeeping burden as described for eligibility. Namely, when using
actual hours or equivalency, each employee will have a different
tracking period based on his hire date.
There is another very key area in which eligibility and vesting are
different when there is an hours-worked component involved. Let us
again consider a plan that requires completion of 1,000 hours in a
12-month period to be credited with a year of service. For
eligibility, both of these requirements must be met; an employee must
complete both 1,000 hours of service and 12 months of employment
before being credited with a year of service. An employee who works
well over 1,000 hours but terminates employment after only 11 months
does not receive credit.
For vesting, on the other hand, an employee is credited with a year
of service as soon as he or she completes 1,000 hours of service
during a vesting computation period regardless of the number of months
worked. Therefore, it is not at all uncommon for an employee to have
received credit for more years of service for vesting than for
eligibility/participation. This is especially important to remember
when determining vesting credit for an employee who terminates but may
have already completed 1,000 hours prior to termination.
One other important difference is the years that must be counted
for vesting. Although all service from date of hire must be recognized
for eligibility, a plan can be written to ignore years prior to its
effective date (or the effective date of any previous plans) and/or
years prior to attainment of age 18 for vesting purposes.
Other Reasons to Count Service
There are several other provisions that may require counting
service. Examples include
Allocation requirements, such as completion of a year of
service, to share in allocations of matching or profit sharing
contributions for a year, and
Definitions of normal retirement using both age and service such
as later of attainment of age 65 or completion of five years of
While there is flexibility to count service using any of the
methods described above, plan documents must specify the methods a
plan elects to use. Therefore, it is advisable to review plan
documents regularly to ensure proper understanding and to seek
assistance from service providers to clarify any points of confusion.
This newsletter is intended to provide general
information on matters of interest in the area of qualified retirement
plans and is distributed with the understanding that the publisher and
distributor are not rendering legal, tax or other professional advice.
Readers should not act or rely on any information in this newsletter
without first seeking the advice of an independent tax advisor such as
an attorney or CPA.