Our company has a retail store that sells items like patio furniture, swimming pool supplies, and equipment. We also have a department that cleans and services swimming pools. The service department is much busier during the summer months, so we hire students to fill these seasonal roles while they are on break from school.
These seasonal employees aren’t really interested in contributing to our 401(k) plan, which hurts our test results. Can we exclude them from the plan altogether?
Yes, it is possible to exclude them; however, before you get too excited about such a simple answer, there are several elements to consider. The first one is the minimum coverage test. Without getting too far into the weeds, that test generally requires a company to cover at least 70% of its non-highly compensated employees under its 401(k) plan. An NHCE is generally someone who earns less than $120,000 from you per year (indexed for inflation) and does not own at least 5% of the company (and is not related to a 5% owner). That means, as long as the group of employees you want to exclude does not exceed 30% of your overall workforce, the exclusion is permitted.
The next critical element is how you go about excluding these workers. The “cleanest” method is via the plan’s eligibility requirements. The reason it is so clean is that anyone who is kept out via this method doesn’t even count toward that 30% number noted above. They can be completely disregarded. Let’s take a quick look at how it works.
The most restrictive requirements a plan can impose are attainment of age 21 and completion of 12 months of service in which the employee works at least 1,000 hours, and it is possible to apply different sets of requirements to different groups of employees. So, if enough of these seasonal employees are under age 21 and do not work at least 1,000 hours each year, you can accomplish your objective by simply amending your plan to apply those maximum requirements to your seasonable staff.
If that doesn’t do the trick, it is also possible to exclude categories of employees from your plan, but that also requires some fine-tuning. The reason is that the IRS doesn’t really like excluding an employee based on the amount of time they work, because they view it as a way to get around the maximum 12-month/1,000-hour waiting period. In the eyes of the IRS, excluding someone based on their status as seasonal or part-time would run afoul of that rule.
That means the exclusion must be couched in terms of some valid business classification such as job function. In your case, that job function might be pool cleaners or even students. Amend your plan to indicate those categories of workers are excluded from the plan, and you are all set.
There are two quick words of caution. One is that any individuals excluded this way do generally count toward that 30% number we mentioned before. The second cautionary note is to be sure you word the exclusion in your plan document to reflect your true intention. If you amend the plan to exclude students as a way to keep out your summer staff and the owner of the company decides to go back to school to get an MBA, he or she is now a student and just got kicked out of the plan. A more precise way to write the exclusion might be “those who are enrolled full-time in an undergraduate program.”
Although we’ve alluded to it a couple times in our answer, any steps you take to exclude employees from your plan—whether via the eligibility requirements or an exclusion by category—must be reflected in the plan document before you implement them. That might mean a plan amendment is necessary, and depending on the type of plan you have, you might have to wait until the start of the next year to implement the change.