Pension Protection Act Blog

The new immigration bill, the Comprehensive Immigration Reform Act of 2007 (S. 1348), raises another question. If alien, or undocumented, workers are recognized as employees for qualified plan purposes in plans which previously did not recognize them as eligible employees, what service will count for vesting purposes?

I think the answer is to this question is contained in Code Section 411’s provision that all service is counted unless specifically excluded by IRC section 411(a)(4), not just service while a participant. The new immigration bill does not include an amendment which adds an exception to Internal Revenue Code section 411(a)(4) to exclude years for vesting credit purposes during periods when a worker was undocumented or during periods when a worker is not a participant.

What is vesting? Vesting is one of those concepts unique to retirement plans and is a crucial building block in plan documents. Vesting is also something pension geeks discuss just about every day, and the average worker probably rarely thinks about until they leave a job and receive a statement saying that they are only receiving a portion of their account balance because they are not fully vested.

How much each employee is vested is updated each year as part of the annual plan administration, and provided to each employee at least once a year, thanks to Section 508 of the Pension Protection Act, which requires that pension benefit statements include vesting information. Simply stated, vesting is the portion of an employee’s benefit which becomes non-forfeitable each year. For example, assume a qualified plan document contains a three year cliff vesting schedule, which means, according to Internal Revenue Code section 411(a)(2)(B), that the plan document provides that:

an employee who has completed at least 3 years of service has a nonforfeitable right to 100 percent of the employee’s accrued benefit derived from employer contributions.

For example, assume that an employer sponsors a plan with a requirement that to become a participant, the employee must complete a year of service. The employer then makes a profit sharing contribution on December 31st each year of $2,000 for each participant who completes a year of service each year. The employer hires Employee Bob on July 4, 2004. On December 31, 2004, Bob has completed more than 1,000 hours of service, so Bob becomes a participant on the next entry date. Assume the plan has two semi-annual entry dates of January 1st and July 1st, so Bob enters the plan on January 1, 2005. In 2005, Bob completes a year of service, so the employer contributes $2,000 into his profit sharing account. Same thing happens on December 31, 2006, so Bob has $4,000 of employer contributions in his profit sharing account on December 31, 2006. Bob is unhappy on December 31, 2006, and makes a New Year’s Resolution to find a new job.

If Bob’s employer counts years of service for vesting purposes from the anniversary date of Bob’s employment, Bob won’t be 100% vested in his account until the third anniversary of his employment date. This means that if Bob quits employment on July 3, 2007, before his third anniversary date, he forfeits his profit sharing account balance and will receive zero because he is zero percent vested. Yes, this means his entire $4,000 account balance in his profit sharing account will be forfeited. Depending on the language in the plan document, the employer can use the forfeited $4,000 to pay plan expenses, apply it to a future profit sharing contribution for the remaining employees, or allocate it to the remaining employees as an additional profit sharing contribution. If Bob quits on July 5, 2007, after he is credited with 3 years of vesting credit, he is entitled to 100% of his account balance, or the entire $4,000.

Bob’s employer is not required to count years of service on the anniversary date of his employment date. Instead of counting years of service from the date of employment and on every anniversary date of employment, the plan document can include a provision that after the first year of employment, the employee’s year of service will switch to the plan year. Assume that the plan year is the same as the calendar year. If Bob’s employer uses this provision, then, for vesting purposes, Bob is credited with a year of service on July 1, 2005, the one year anniversary of his employment date. His vesting credit period then switches to the calendar year. If he completes a 1,000 hours of service between January 1, 2005, and December 31, 2005, he is granted a second year of vesting credit on December 31, 2005. If he completes a third year of service in 2006, he then is fully vested on December 31st, 2006, and will receive 100% of his account balance if he quits after that date.

These two examples assume that all service is counted for vesting purposes, and one of the exceptions in Code section 411(a)(4) does not apply. ERISA attorneys like to say that not every vesting year is credited equally. For crediting vesting service, Internal Revenue Code section 411 does not count some years for vesting credit. Code section 411(a)(4) states:

In computing the period of service under the plan for purposes of determining the nonforfeitable percentage under paragraph (2), all of an employee’s years of service with the employer or employers maintaining the plan shall be taken into account, except that the following may be disregarded:

(A) years of service before age 18,
(B) years of service during a period for which the employee declined to contribute to a plan requiring employee contributions;
(C) years of service with an employer during any period for which the employer did not maintain the plan or a predecessor plan (as defined under regulations prescribed by the Secretary);
(D)service not required to be taken into account under paragraph (6);
(E) years of service before January 1, 1971, unless the employee has had at least 3 years of service after December 31, 1970;
(F) years of service before the first plan year to which this section applies, if such service would have been disregarded under the rules of the plan with regard to breaks in service as in effect on the applicable date; and
(G) in the case of a multiemployer plan, years of service -
(i) with an employer after -
(I) a complete withdrawal of that employer from the plan (within the meaning of section 4203 of the Employee Retirement Income Security Act of 1974), or
(II) to the extent permitted in regulations prescribed by the Secretary, a partial withdrawal described in section 4205(b)(2)(A)(i) of such Act in conjunction with the decertification of the collective bargaining representative, and

(ii) with any employer under the plan after the termination date of the plan under section 4048 of such Act.

While some of these exceptions are not fair, they are clear. A worker who is age 17 and completes a year of service can have an employer who excludes that year of service from vesting credit simply because it was earned before the worker attained age 18. Code section 411(a)(4) permits excluding this year. For a year of service not to be credited for vesting purposes, it must fit within one of the exceptions under Code section 411(a)(4).

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