Did you know becoming a participant and earning a contribution are two separate events? An employee could become a participant and not earn a contribution. Plan eligibility and contribution requirements are different aspects of your plan document.
Let’s start by defining the statutory requirements to become a plan participant not only for your ESOP but for most other qualified retirement plans. IRC Section 410(a)(1)(A) states plan participation cannot exceed the later of age 21 and 1 year of service. With most plan documents this is very common. A plan can establish 2 years of service for eligibility into an ESOP, but participants must be immediately vested in their account. I’ve rarely seen this provision used.
After the eligibility requirements of the plan have been met, an employee will become a participant in the Plan. IRC Section 410(a)(4) states an employee must enter the ESOP no later than the earlier of (1) the first day of the plan year which begins after the date the employee completes the statutory age and service requirements, or (2) six months following the date the employee completes the statutory age and service requirements. We typically see semi-annual entry of January 1st and July 1st for most calendar year plans.
These are just the minimum requirements put in place by the IRS. For example, you could have no hour requirement and have the date of hire as the entry date into the Plan. Another example could be minimum age of 18, working at least 500 hours and allowing for entry first of any month once the requirements are met. Whatever you choose it is important you follow what your plan document says as it could result in an operational failure. The provisions can always be changed by drafting a plan amendment.
Now that we’ve looked at requirements to become a plan participant, let’s move on to how to earn a contribution (and/or reallocated forfeitures) for the plan year. Most plan documents will follow the same hours requirement as a condition for contribution eligibility as you would to become a plan participant. The only requirement outlined by the IRC is a plan cannot require more than 1000 hours worked to receive a contribution.
Although this is not a requirement, we see most plan documents enforce the last day of the plan year rule. With this provision, a participant must be employed on the last day of the plan year in order to share in the allocation of contributions. For example, if a plan is a calendar year plan, an employee must be employed on December 31st. Working 1000 hours and being employed on the last day of the plan year are very common requirements to receive a contribution for a plan year.
To add another layer into this the plan document may have exceptions if the employee terminated on account of death, disability, or retirement. In those cases, we typically see no hour or last day requirements need to be met. Please note the plan document should define these events.
In conclusion being a plan participant does not automatically allow you to share in the allocation of contributions. Please refer to your plan document and follow the procedures accordingly. If you have any questions, please contact your Blue Ridge plan administrator. They’ll be happy to help.