Eligibility and Vesting Requirements

Understanding eligibility and vesting requirements is fundamental to qualified retirement plan administration. These rules ensure that retirement plans benefit a broad range of employees while providing flexibility for plan sponsors.

Minimum Eligibility Requirements

ERISA establishes minimum eligibility standards that apply to all qualified retirement plans. These standards prevent employers from excluding employees for extended periods while still allowing reasonable waiting periods.

The 21-and-1 Rule

The standard eligibility requirement under ERISA is commonly called the "21-and-1 Rule":

Key Point: An employee must satisfy BOTH requirements before becoming eligible for the plan.

Defining a Year of Service

A year of service equals 1,000 or more hours worked during a 12-month computation period. This threshold ensures that full-time employees qualify relatively quickly while excluding truly casual workers.

Two-Year Eligibility Election

Employers may elect to require two years of service instead of one, but this option comes with an important trade-off:

• Benefit: Extends the waiting period to two full years
• Requirement: Must provide 100% immediate vesting for ALL employer contributions
• Critical Exception: The two-year eligibility election is NOT available for 401(k) plans

This restriction exists because Congress wanted to encourage participation in 401(k) plans, and a two-year waiting period would discourage employee deferrals.

Special Rules for Educational Institutions

Tax-exempt educational institutions have a special provision:

• May require employees to reach age 26 before becoming eligible
• This accommodation recognizes that educational institutions often employ graduate students and other temporary workers

Plan Entrance Dates

After meeting eligibility requirements, employees don't necessarily enter the plan immediately. Plans must specify entrance dates when new participants are admitted.

Minimum Entrance Date Requirements

Example: An employee meets eligibility on March 15. With entrance dates of January 1 and July 1, the employee would enter the plan on July 1.

SECURE Act: Long-Term Part-Time Employees

The SECURE Act of 2019 created new eligibility rights for long-term part-time employees in 401(k) plans. This rule applies to plan years beginning after December 31, 2020.

Long-Term Part-Time Employee Requirements

Important: This rule applies ONLY to 401(k) salary deferral contributions. Employers may still exclude long-term part-time employees from employer matching and profit-sharing contributions.

Vesting Schedules

Vesting refers to an employee's ownership rights in employer contributions. While employees are always 100% vested in their own contributions, employer contributions may be subject to vesting schedules.

Types of Vesting Schedules

Cliff Vesting: The participant becomes 100% vested after a specified period, with 0% vesting before that point.

Graded (Graduated) Vesting: Vesting increases incrementally over time until reaching 100%.

Vesting Schedules by Plan Type

Standard DC Graded Vesting Schedule (2-6 Years)

Standard DB Graded Vesting Schedule (3-7 Years)

Employee Deferral Contributions

Critical Rule: Employee elective deferral contributions (such as 401(k) salary deferrals) are ALWAYS 100% vested immediately.

This applies to:

• 401(k) employee deferrals
• 403(b) employee deferrals
• 457(b) employee deferrals
• SIMPLE IRA contributions
• Employee after-tax contributions

The immediate vesting requirement recognizes that these are the employee's own funds being set aside, not employer contributions.

Safe Harbor 401(k) Vesting

Safe harbor employer contributions have special vesting rules:

100% Vesting Events

Certain events trigger 100% vesting regardless of the schedule:

• Normal retirement age attainment
• Plan termination
• Death of the participant
• Disability (if plan provides)
• Change in vesting schedule (participants may elect to retain prior schedule)

Cash Balance Pension Plans

Cash balance pension plans are defined benefit plans that use a special vesting rule:

• Must use 3-year cliff vesting (or more generous)
• Cannot use 5-year cliff or 3-7 graded schedules
• This accelerated vesting helps younger workers who might otherwise lose benefits

Employer Flexibility

Employers always have the option to be more generous than the minimum vesting requirements:

• Immediate 100% vesting is always permissible
• Faster graded schedules are allowed
• Shorter cliff periods are acceptable

Many employers choose immediate vesting to attract and retain talent, even though it means forfeiting the ability to recapture unvested amounts from departing employees.

Vesting Calculation Example

Scenario: James participates in a 401(k) plan with a standard 2-6 year graded vesting schedule. His account balance of $200,000 consists of:

After 2 years of service (20% vested in employer contributions):

Key Point: Earnings follow the same vesting rules as the underlying contribution source.