Properly crediting 401(k) accounts when there’s a break in service

401k plans, DOL & IRS rules, Retirement Plans Add comments

When an employee leaves a company before fully vesting, and then returns to work for the company, you want to correctly handle the vesting credit for previous employment. Here is a good explanation from the IRS about how to manage the process:

Question:

Our 401(k) plan uses a 6-year graded vesting schedule for matching contributions and forfeits the nonvested portion in a terminated participant’s matching contribution account after a cash-out or 5 consecutive 1-year breaks in service. Recently we rehired, on a full-time basis, a former employee who had 2 years of vesting service when he was cashed out in 2008. When he quit, he was 20% vested in his matching contribution account, and during his absence, he accrued 3 consecutive 1-year breaks in service. Must we give him credit for those 2 years of vesting service?

IRS answer:

Because the employee was rehired prior to having 5 consecutive 1-year breaks in service, his 2 pre-break years of service must be counted for vesting of his matching contribution account. If he repays the entire amount of the distribution, the amount forfeited when he was cashed out will be restored.

Breaks in service
Plan participants have a 1-year break in service for any year in which they do not complete the minimum hours of service required by the plan’s terms (for example, 501 hours).

5-year break-in-service rule
Your plan uses the special break-in-service rule where an employee’s post-break service is counted for vesting in pre-break accounts only if the employee is rehired prior to having 5 consecutive 1-year breaks in service.

Vesting of pre-break account
Although your plan distributed the employee’s entire vested account balance in 2008, it must give him the opportunity to repay his entire distribution to the plan within 5 years of being rehired because he didn’t have 5 consecutive 1-year breaks in service. If the rehired employee repays the entire distribution to the plan, then you must reinstate the amount he forfeited and vest him in the reinstated amount based on both his pre and post-break years of service.

Vesting of post-break account
Your employee was 20% vested when he left your company in 2008. He was rehired after having only 3 consecutive 1-year breaks in service (2009 – 2011). Therefore, your plan must credit his 2 pre-break years of service for vesting.

Post-break waiting period
A plan may require an employee to complete up to 1 year of vesting service after being rehired to receive vesting credit for his pre-break years of service. If your plan has a post-break waiting period, your rehired employee must complete another year of service before he would be credited with 3 years of service (his 2 pre-break years plus his 1-year waiting period).

Types of contributions
Participants are always 100% vested in their salary deferrals. The plan’s 6-year graded vesting schedule applies only to the employer matching contributions.

Tags: 401(k), fiduciary responsiblity, IRS, Retirement Plans, vesting