How strict can I set the vesting, or the eligibility, for my pension plan? What does the word "vesting" mean, anyways? I’m a business owner and I don’t want any of my employees in the plan, I want it to just be me – is that legit? Let’s talk it through.
How strict can I set the vesting, or the eligibility, for my pension plan? What does the word "vesting" mean, anyways? I’m a business owner and I don’t want any of my employees in the plan, I want it to just be me – is that legit? Let’s talk it through.
Welcome to Retirement Plans A to Z, I’m Sue Burnett w Monarch Financial Advisors, and we’re going to break down these complex things called qualified retirement plans into smaller pieces – 26 pieces, to be exact, from A to Z, with maybe a few extras thrown in. This episode focuses on the letter V: Vesting and Eligibility. What is vesting? How is it used in plan design? How strict can I set the vesting, or the eligibility? I’m an owner and I don’t want any of my employees in the plan – is that legit? Let’s talk it through.
Episode V: Vesting & Elig Tackle elig first – first need to get into the plan, before deciding what you’re entitled to! Episode not talking about SEPs and SIMPLEs – that vesting is 100% immediate, as soon as $ in, EE can take it. Elig for these is a little different. So – vesting, focused on DBs, PS. Elig – include 401k and SH too.
· FF: Before ERISA – big pension legislation enacted in early 70’s – participating and vesting were all over the place, No rules, no requirements. Ex – AmEx had a plan where you needed to be age 60 and have 20 years of svc before you were due anything! ERISA established participation rules, and vesting needed to be within 10 years (eventually changed to be even lower)
· Elig - IRS has safe-harbor elig provisions to restrict who comes into the plan. Don’t have to allow ees under age 21, or who have worked for less than a year. Also, can exclude PT – defined as less than 1,000 hrs. Someone working 3 days a week is probably close to 1,200 hours, which you may consider PT. Or, someone works 40 hrs per week from May through August, which You may consider FT. Per IRS, hours calculation – 3 days a week FT, 40 hours for 5 months not.
· Can always relax these restrictions – this is strictest you can go, if you want to have vesting provs apply. Lower age to 18? Sure. Lower hours rules to 500 hours, because your spouse works 2 days a week? Sure. Allow immediate elig for anyone hired before a certain date? Absolutely. Can always let in MORE people – these rules give you max people you can exclude.
· If you want to prevent people from coming in for as long as possible, you CAN require a 2 year wait instead of one year. This means an ee needs to work at least 2 years at 1,000 hours per year to come in. However, when they’re in, need immediate vesting – ie elig for any ben they accrue right off the bat. Pros and cons to this – longer wait to get in, but get the benefit a lot faster once theyre in – dep on your ees and the turnover you experience.
· One other way to restrict who enters the plan is to fully exclude particular groups of people. Usually this is based on a particular job title, or a location – in the eligibility section, it will specify this group as not being elig for the plan at all, regardless of being age 21 or working full time for a year. Large corps do this all the time – gen they’d have a sal plan for all their salaried ees, and an hourly plan - or multiple hry plans for diff unions. In sal plan, excluded ees would be any hry ee. In union plan, excluded ees would be sale es, or any hry ees not in the union. Excluding whole group, can’t let some in and not others. And, in some of the tests that we have to run to be sure that the plan isn’t discrim against ees, particular #s of people that need to be included – can’t exclude too many.
· FF – I designed a plan a few years ago for dr’s office with 150 ees, owners were husband and wife. Using the rules, excluding as many as possible, only covered 40 ees and the 2 docs, with almost 90% of the total contrib going to owners. Can’t exclude all ees – but sometimes you can exclude an awful lot of them.
· Those are options for restricting elig, or getting into the plan. Once in, how long can you require your ees to work before paying them full bens? For 401(k) contribs or SH contribs, covered in episode T, this $ is vested immediately,
· 2 IRS SHs for this. First is 5 year cliff. Similar to falling off a cliff, either you’ve fallen, or you haven’t – with this, either work for 5 years 1,000 hrs per year and get full ben, or you haven’t – and you get nothing. IRS says that if the plan is TH – majority of ben is for owners – must become 3 year cliff. Plans we design geared to owner – aiming for TH plan – so this is more often than not a 3 yr cliff. See a lot in defined ben plans, get entire ben after 3 yrs or nothing.
· Other SH is called 6 year graded. In this vesting sch, need to work for 6 years before elig for full ben. But, after 2 years, you’re eligible for 20%, goes up 20% each year after that. So, from year 2, you’re vested in 20%, then 40%, then 60, 80, finally 100% after year 6. This is really common in profit sharing plans, get a piece of ben paid out if leave prior to 6 years.
· If ee is vested, and leave, elig for distrib – administrator would provide them w paperwork to choose how they want to receive their benefit. More on distribs in Ep D.
· What if EE isn’t vested, or they’re only partially vested, and they leave? What happens to the contribution? Money that they aren’t vested in is called a forfeiture, because ee is forfeiting that benefit. The $ stays in the plan, up to owner how forfeitures are treated. There are a few diff options – for DB plan, $ is used to offset required pmts for the next year – if there’s $5k in forfeitures and biz needs to contribute $100k, only need 95k in cash. PS plan, can allocate it to all remaining ptps prorata by their PS balances. There are a few other options too…in all cases, $ stays in the plan, doesn’t come out and go back into the company’s financials. Also, owner does need to explicitly choose – allocation of forfeitures is specified in the plan document.
· For our final fun fact, one of most creative ways I’ve seen to use elig and vesting – biz where elig included everyone, excluded all job classes except for part-time ees. Minimized costs, conts for ees were a % of pay and they weren’t making much. 2 year elig – most were gone after a year, so no vested benefit. Few made it through – low dollar amount, didn’t materially impact anything because most of contrib went to owners. Pretty creative – and within the rules.
· Wrapping it all up – owner can put rules and restrictions on when ees are elig to be a participant in the plan, and when they are vested in a benefit. IRS has some safe harbors – auto approved – can always relax restrictions, but can’t make more strict. How owner sets up plan is up to them – we can help make sure that the plan is structured in the way that’s best for that biz, and give pros-cons of diff elig and vesting requirements.
· Want to hear more? The other episodes mentioned here are D (distribs), and T (types of plans)
· Have any questions? Shoot me an email at MRS@gmail.com. Thanks for listening in – and have a great rest of your day.