How to Get Something for Nothing

What’s a Year-of-Service?….What Do You Need It to Be?

Pension jokes and dad jokes can be corny, predictable, and unoriginal, but the truth is, they often tell the truth. One common pension joke is that if you ask an actuary how much is 2+2, he will respond: “How much do you need it to be?” Param pam. Well, I can’t be sure, but an actuary may have been behind the design of the available eligibility and vesting service methods, because under most of them, a year does not mean twelve months. Like an actuary could make 2+2 be whatever it needs to be, an employer can choose what a year of service means by using different counting methods. In most cases, a year does not mean twelve months and many of the counting methods are a something-for-nothing giveaway!

Extra! Extra!! Freeeee Service Credit!!

For example, if one year of service = 1,000 hours worked during a plan year:

• Under the traditional Actual Hours Method, a full-time participant hired in June can attain one year of service by December, in seven months: One year of service in seven months!
• Under the traditional Actual Hours Method, the determination period often switches from the anniversary of the date of hire for the first determination year, to the plan year for the second determination year. A 20-hours per week employee hired in June xxx1 will be credited with the first year of service on the hire date anniversary in June xxx2 , and with another year of service in December of xxx2: Two years of service for nineteen months of work!
• Under the Elapsed Time Method, an employee receives credit for a period of service if they are still employed at the end of that period, regardless of the hours actually worked. For example, if Snowplow Sam is hired on October 1, xxx1, he receives credit for a year of service if still employed on September 30, xxx2. Credit is given regardless of the number of hours worked, even if he terminates employment and is rehired prior to September 30, xxx2. If Snowplow Sam separates from employment five months later, on March 1, but returns on or before September 30, he will be credited with one year of service: One year of service for five months of work!
• Under the Equivalency Method, the regulations provide hours-worked equivalencies for a specific length of time. Under this method, hours are credited based on a unit of time. If the employee is credited with at least one hour of service during that unit of time, a fixed number of hours are credited for that unit. The units of time that may be used are days, weeks, semi-monthly payroll periods and months. The hours credited for these units are:
  • 10 hours for a day,
  • 45 hours for a week,
  • 95 hours for a semi-monthly payroll period, and
  • 190 hours for a month.
  • The employee’s actual hours worked for that unit of time are irrelevant.

The Interaction Between the Break-in-Service Rules and Service Credit

Using Monthly Equivalencies: More and more free service credit!!!! That’s what our sample employee, Summer Intern, receives because of the interaction between the equivalency service credit method (190 hours a month) and the break-in-service rules in a plan document with a six months of service eligibility requirement.

• Summer Intern starts her accounting internship on 6/1/2024
• She works from 6/1/2024 – 8/8/2024 then goes back to school with the intention of resuming full time work on 7/1/2025. No work is performed from 8/8/2024-7/1/2025
• Summer begins working again on 7/1/2024 as a full-time employee.

The plan document states that:

If the Employer has selected an Equivalency Method of counting days or months of Eligibility Service in the Adoption Agreement, an Employee shall be credited with Eligibility Service for the aggregate of the periods beginning with the Employee’s Employment Commencement Date (or Reemployment Commencement Date) and ending on his subsequent Severance Date; provided, however, that an Employee who has a Reemployment Date within the 12-consecutive-month period following the earlier of the first date of his absence or his Severance Date shall be credited with Eligibility Service for the period between his Severance Date and his Reemployment Date. A day of Eligibility Service shall be credited for each day on which an Employee is credited with Eligibility Service. Months of Eligibility Service shall be measured from the Employee’s Employment Commencement Date or Reemployment Commencement Date to the corresponding date in the applicable following month.

Because of the interaction between the break-in-service rules and the equivalency method:

• Summer is credited with six months of eligibility service 12/1/2023 – 6 months after her Employment Commencement Date, because her Reemployment Date is within the 12-consecutive-month period following the earlier of the first date of absence or the Severance Date of 8/8/2024.

Using the Elapsed Time Method: With the elapsed time method, one day of work can make a big difference, especially when we consider the interaction with the break-in-service rules.

Hold On for One More Day or…No Credit: If an employee starts working on January 2nd, xxx1 and resolves to start the new year at a different employer, because 364 days is enough, so he/she takes off and never looks back, the employee will not be credited with one year of service under the elapsed time method. The participant should have heeded Wilson Phillips’s advice and held on for one more day. What a difference one day makes!

I was King for Just One Day: Double Credit: Conversely, Wilson Philips would have known not just to hold on until January 2nd ,xxx2 to quit, but they would have also returned to work on the following January 1st, xxx3, so that there is no break in service for year xxx2. Who knew the Thompson Twins could inspire Wilson to get credit for two years having only worked one more day.

Clearly, a plan using the elapsed time method will not be able to exclude part-time employees or seasonal employees as easily as plans using the hours counting method can. Taking it one step further, using the elapsed time method could potentially render the new Long-Term, Part-Time (LTPT) employee rules inapplicable, because employees will easily exceed the 500-hour threshold that drives the LTPT rules. Fortunately, plans can mix and match the available methods to allocate service credit to determine eligibility, vesting, and benefit accruals. Plan design options are abundant. For example, different service methods may be applied to different classifications of employees, as long as the classifications are reasonable and consistently applied. More specifically, the Actual Hours Method could be used for hourly or seasonal employees while the Elapsed Time Method is used for salaried employees. When it comes to plan design, there is usually a way to achieve the employer’s business goals.

Administrative Simplicity vs. Fairness

Employers must evaluate each option and the trade-offs between administrative simplicity and fairness, two goals that can be mutually exclusive. Any method that does not count actual hours will give free service credit for hours not actually worked, but the administrative simplicity may be worth causing some inequity. The method used may be simple, but it may not be fair.

Speaking of fair, simplicity has a downside for employer too. Careful what you wish for! Alternative counting methods are simpler, but more costly. Granting service credit for hours not worked can increase employer contributions for the additional eligible employees, or because additional service credit granted results in bigger distributions and lower forfeitures that can reduce future employer contributions. You get what you pay for!

Each employer’s goals are individual and driven by the sophistication of the available payroll systems, the nature of the industry, and what competitors are offering their employees. In the end, a good plan design will consider all the factors and when it comes to counting service, it will define a year as….whatever the employer needs it to be.

Examples of the Multiple Ways to Count a Year of Service if One Year = 1,000 Hours in a Plan Year

• Actual Hours Method: An employee who works 40 hours a week will have worked 1,000 hours in 25 weeks or 6.25 months. If a plan has monthly entry dates, an employee hired on May 1, 2023 will have completed one year of eligibility service in December, upon completion of 1,000 hours of work, and would enter the plan on January 1, 2024. By the end of the plan’s year, December 31, 2024, the participant will have two years of vesting credit. Please note that the entry date does not start the vesting clock, the hire date does. After approximately eighteen months of employment, the participant will have one year of active plan participation and two years of vesting credit.
• Elapsed Time Method: A Full Year – Using the elapsed time method, a participant hired on May 1, 2023 would have a one-year period of service after April 30, 2024. Although the “one-day-later” example above is rather extreme, it demonstrates the rules for a much more common situation: internship programs. In Example 1, the computation period was the plan year. A year of vesting service would be granted if Ron completed 1,000 hours of service in 2019, in 2020, in 2021, etc. Under the elapsed time method, there is no such thing as a computation period. You just measure straight service time, regardless of what plan year it’s in.
• Example 3: Ron quits Acme. If Ron quits on 9/3/2020, that is his severance date. Since he worked more than 12 months but less than 24 months, he would have a one-year period of service for vesting.
• Example 4: Ron becomes disabled. If Ron goes out on disability on 9/3/2020 and does not return to work, his severance date is 9/3/2021, one year after the absence began. He would have a two-year period of service for vesting in that case.
• Example 5: Ron has leave of absence, then quits. If Ron takes a leave of absence on 9/3/2020 but then quits on 12/15/2020, his severance date is 12/15/2020, even though a full year hasn’t elapsed since he started his leave of absence. As of 12/15/2020, he has a one-year period of service for vesting. In fact, if Ron quit on any date up to 6/30/2021, he would still have a one-year period of service for vesting.
• Example 6: Ron quits and is rehired within 12 months. As noted above, if an employee is rehired within 12 months of severance, he gets credit for the time from the severance date to the rehire date. If Ron quits on 9/3/2020 but is rehired within 12 months, then he gets credit for all of the days between the quit date and the rehire date – even if he just comes back for a day or two. Say he is rehired on 8/16/2021. His total period of service then would be 7/1/2019 through 8/16/2021, which includes the time between 9/3/2020 and 8/15/2021 when he wasn’t employed by Acme. This applies for both eligibility and vesting for employees who quit, were discharged, or retired.
• Example 7: Ron quits and is rehired after 12 months. Now suppose Ron is rehired on 9/10/2021. This is more than 12 months after the severance date. He would not get credit for the days from 9/3/2020 to the rehire date. Rather, the clock would restart on his rehire date. His service beginning on the rehire date would be added to his 7/1/2019 through 9/3/2020 service. The plan could adjust his hire date to account for the period of severance, or it could track the two discrete periods of service separately and add them together.

The above examples all relate to the determination of vesting service. Here are a few examples relating to eligibility:

• Example 8: Ron quits before his entry date and is rehired within 12 months. Assume Ron was hired on 5/1/2019 (different from the previous examples). Ron quits on 5/15/2020, after his one-year anniversary but before his entry date of 7/1/2020. He is rehired on 10/4/2020. Ron will enter the plan immediately on the date of his rehire.
• Example 9: Ron takes a leave of absence before his entry date and returns to work. Again assume Ron was hired on 5/1/2019. He starts a leave of absence on 5/15/2020 and returns to work on 10/4/2020. On 10/4/2020, he will enter the plan retroactively to 7/1/2020. This is a slightly different result than in Example 8 because Ron did not have a severance from service in this case.
• Example 10: Ron quits before a one-year period of service, is rehired. Ron is hired on 7/1/2019, quits on 10/1/2019, and is rehired on 12/1/2020. His eligibility date may either be 9/1/2021 based on 12 months worked or 8/31/2021 based on 365 days worked. Either way, his entry date is 1/1/2022. The employer may use a single adjusted hire date of 9/1/2020 to reflect the 14 months he was gone, or it can measure service starting at 12/1/2020 and add to that total the initial three months of service before Ron quit.

Other Notes

Different service methods may be applied to different classifications of employees, so long as the classifications are reasonable and consistently applied. The hours counting method could be used for hourly employees while the elapsed time method is used for salaried employees, for instance.

The elapsed time method has rules about cancelling service that are analogous to the break-in-service rules. However, it is very rare for service to be cancelled. The one-year hold-out break-in-service rule applies as well.

There are rules about what happens when a plan is amended from the hours counting method to the elapsed time method and vice versa that are beyond the scope of this article.

While the elapsed time method is nice because you do not have to count hours worked, the sword cuts both ways. A plan using the elapsed time method will not be able to exclude part-time employees as easily as plans using the hours counting method can. Under elapsed time, a worker employed for a full year is eligible for the plan whether he’s completed 20 hours of service or 2,000.

(A part-time worker could possibly be excluded by job classification or some other criteria, but that is more cumbersome than simply being able to ignore employees who never work 1,000 hours.)

Likewise, it is harder to exclude seasonal employees from a plan that uses the elapsed time method because you have to give credit for all the absences until there is one that goes on for more than 12 months consecutively.

The fact that part-time employees may not be disregarded, along with the possibility of having to piece together service credit in case of absence or rehire, makes the elapsed time method a nonstarter for many businesses.

Consider Ron, a full-time employee of XYZ Corporation who was hired on 7/1/2019. Ron is looking forward to joining The XYZ Retirement Plan, which operates on a calendar year basis and has fairly typical provisions, including a one year of service eligibility requirement and semiannual entry dates (January 1 and July 1). It doesn’t matter whether the XYZ plan is defined contribution or defined benefit; the same concepts apply in both.