401(k) FAQ: Coverage and Eligibility

Q: Is it essential to include all employees of the employer in a 401(k) plan?

A: If the plan meets certain coverage requirements of the Internal Revenue Code, not all employees need to be covered. An employer should be careful when limiting coverage for many reasons; in particular, a change in the composition of the groups which are covered can result in a failure to meet coverage requirements. This can lead to disqualification of the plan by the Internal Revenue Service.

Q: How should the 401(k) eligibility requirements be determined?

A: The law generally permits establishing a maximum age of 21 and a service limitation of one year. When considering eligibility requirements, the employer should note that although a delay in participation may reduce short-term costs, it will make the 401(k) plan less attractive to many prospective employees. Also, recent favorable changes in the law may encourage employers to seek immediate eligibility. Frequently, there are dual eligibility requirements for the plan. Allowing employees who are present on the day the plan is adopted to be immediately eligible and requiring a waiting period for employees hired after that date is not uncommon.

Q: We are a small subsidiary of a large corporation that has a 401(k) plan. Can we adopt a 401(k) plan that only covers our employees?

A: This is not an easy question to answer. It depends on the employee makeup of the two companies. Since both plans would have to pass certain coverage and nondiscrimination tests, an opinion as to whether this is possible with separate plans should be requested from the firm that administers the parent company's plan.


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