Sooner or later, most companies will have an employee who leaves and comes back again. As is so often the case, the retirement plan rules related to rehires are quite different than those that apply to other areas of employment and benefits.
First Order of Business
Before wading too far into this topic, it’s important to first settle on whether the employee in questions is truly a rehire. In many situations, it can be a bit ambiguous as to whether there was a termination in the first place. If there wasn’t, there can be no rehire. Let’s consider several scenarios.
Leave of Absence
There are many reasons an employee may take a leave of absence, and there are several other laws, including the Family and Medical Leave Act (FMLA) and the Uniformed Services Employment and Reemployment Rights Act (USERRA) that may confer special employment rights on those who are covered. Depending on the specifics of any given situation, when an employee returns from a leave of absence he or she may actually need to be treated as if continuously employed.
Inconsistent Work Schedule
Some employees may have inconsistent work schedules, working more hours one month and very few or no hours in another. This may be more prevalent in industries such as retail sales or hospitality, but there are several other fairly common arrangements that fall into this category:
- “Per Diem” Employees – work a day here and there on an as needed basis (often in healthcare-related fields);
- Interns - consistently work during each school break but do not work at all while school is in session;
- Seasonal Employees – return to work at the same general time each year (e.g. groundskeepers at a golf course), but do not work in the off-season.
Are these employees terminated during each gap in their work schedule or are they continuously employed but not on the schedule? Again, answering that question is a critical first step in determining whether the rehire rules apply.
Transfers
Another variation is when an employee transfers from one division, location or subsidiary to another. When the transfer is within the same group of “related” companies, it is not a termination and a rehire; it is continuous employment…even if the divisions or locations have separate payrolls or financial reporting structures.
You may be wondering why there are quotes around the word related. The reason is that there are complex rules that require companies with certain overlap in ownership or business operations to be treated as a single employer for retirement plan purposes. An employee who transfers from one such related company to another is again considered as continuously employed.
Rules of the Road
Once we know whether we’re dealing with a rehire situation, there are two general rules we must review. They are known as the Rule of Parity (RoP) and the One-Year Holdout Rule (OYHR).
Rule of Parity
The RoP provides guidance on when a rehire’s pre-termination service can be permanently disregarded upon rehire. In short, the employee in question must have been:
- A participant in the plan prior to termination;
- 0% vested at the time of termination; and
- Terminated long enough to incur five consecutive breaks in service.
All three requirements must be met. The first is straight-forward; however, keep in mind that someone is a participant if they are eligible for the plan even if they have not chosen to contribute.
The vesting requirement is a bit trickier and depends on the employee’s actual account. Since salary deferrals must be fully vested at all times, any employee who has made 401(k) deferrals does not meet the vesting requirement. In other words, there are no circumstances that would allow the company to ignore pre-termination service regardless of how much time has passed between termination and rehire.
If the employee has never deferred or the plan doesn’t allow deferrals, we turn our attention to company contributions. It is obvious whether a person has vesting credit if a contribution has been made, but what about an employee who is vested but has no account balance? For example, how would we treat an employee who has worked for the company for two years and is 20% vested but the company has not made any contributions during that time frame? The employee is 20% vested in an account with nothing in it.
The rules are somewhat open to interpretation on this point, but seem to suggest that such an employee would be treated as 0% vested in applying the RoP. Others argue that such an interpretation seems contrary to the intent of the law. Should this situation arise, it is a good idea to seek assistance from an experienced consultant and to make sure that whatever interpretation is adopted is applied consistently.
That brings us to five breaks in service. As a general rule, a break in service is a plan year during which an employee works fewer than 501 hours of service. A couple of quick examples may help here.
Arthur terminates employment on January 31, 2017, having worked 100 hours year-to-date. Assuming he isn’t rehired before then, he would experience his first break in service at the end of 2017 and his fifth at the end of 2021.
Penelope terminates employment on May 31, 2017, having worked 800 hours year-to-date. Since she completed at least 501 hours of service prior to termination, she does not have a break in service for 2017. That means her first break is in 2018, and her fifth is in 2022.
For plans that use the elapsed time method of counting service, the fifth break in service occurs when the employee has been terminated for 60 consecutive months
One-Year Holdout Rule
This rule is much simpler in many ways and allows a company to temporarily ignore a rehire’s pre-termination service. Under the OYHR, once an employee incurs a single break in service, pre-termination service is ignored until he or she completes 1 year of service following rehire. Then, all pre-break service is immediately reinstated retroactive to the date of rehire. A break in service is measured the same way as described above for the RoP, and a year of service generally means a 12-month period in which the employee works at least 1,000 hours.
Putting the Rules Into Play
The above analysis is the hard part. If you’ve made it this far, putting those results into play is much easier. There are two main reasons that we care about all of these rules – to determine eligibility and vesting. Let’s take a look at how the results apply to both of these important determinations.
Eligibility
An employee who didn’t meet the plan eligibility requirements before terminating is the most straight-forward - he or she must complete those requirements irrespective of breaks in service, etc. Someone who was a participant prior to termination re-joins the plan immediately on rehire unless either the RoP or OYHR applies.
A participant who satisfies all three requirements under the RoP is treated as a new hire as of the re-employment date and must satisfy the plan’s eligibility requirements that are currently in place in the same manner as any other new employee. Keep in mind that it is somewhat unusual in a 401(k) plan for an individual to meet all of the RoP requirements, so proceed with caution and double-check your findings if it looks like a former participant will be treated as a new hire.
The OYHR can present some unique challenges since it provides retroactive credit for pre-termination service. Another example will help to illustrate.
Harold is a former participant who is rehired for 20 hours per week on December 1, 2017. Under the OYHR, he completes one year of service after his rehire on November 30, 2018, and his pre-termination service is reinstated retroactively to his rehire date, making him eligible for the plan in 2017. If the company made a contribution for 2017, Harold is eligible to share in it even though the company could not have known it at the time they made the deposit. The company is obligated to make a 2017 contribution for Harold, but they would have to deduct it on their 2018 tax return.
Another quirk of the OYHR is whether and how it can be applied to a 401(k) plan. A 401(k) plan, by its nature, requires a participant to make a deferral election before the pay becomes available. By the time a participant retroactively re-enters the plan under the OYHR, he or she has already been paid for a year, making it impossible to defer. That could be interpreted as a violation of the terms of the plan. As a result, the OYHR should not be applied to the 401(k) portion of a plan.
Vesting
Both the RoP and the OYHR are applied in a similar manner for vesting. There is, however, one very important difference related to the OYHR - the computation period for determining one year of service can be different for eligibility than for vesting. Specifically, it is counted from rehire date for eligibility, but the vesting computation period in many plans is always the plan year. So, using the above example, although Harold is rehired on December 1, 2017, he will not complete 1,000 hours by the end of the plan year (December 31, 2017) and would re-set the clock on January 1, 2018. That means he would not be given retroactive credit for vesting until December 31, 2018, one month later than when his service was recognized for eligibility.
Conclusion
Dealing with rehires can be challenging on many fronts. Establishing a procedure to review employment history will help meet those challenges with regard to the retirement plan. Both the RoP and OYHR are optional provisions, so it is critical to check your plan document. When questions arise, a call to an experienced TPA or consultant at the beginning will go a long way to preventing even more daunting challenges down the road.
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