Vermont Bar Journal, Vol. 40, No. 2 Fall 2014, Vol. 40, No. 3 | Page 26

Retirement Plans: What to Select When You’re Selecting

If the plan has a 401(k) provision some
employers like to use a shorter eligibility
requirement in order to attract employees.
If that is what it takes to be competitive in
recruitment the plan can have one requirement for 401(k) participation and a longer
requirement for profit sharing. However,
the price of having dual eligibility requirements is at the very least more complication. In addition, most plans of small employers are subject to minimum benefit requirements. As a result at least 3% has to
be funded for employees who enter earlier
for 401(k) purposes.
Vesting
As noted above, if a plan has an eligibility
requirement of one year or less, it can also
have a vesting schedule. That means that
a participant must complete a certain number of plan years of service to be entitled to
his profit sharing account balance. He’s always fully vested in his 401(k) deferrals. The
two choices here are a three-year cliff vesting schedule or a six-year staggered vesting
schedule of 20% per year, beginning with a
participant’s second plan year of service.
In a plan with three-year cliff vesting, an
employee terminating employment with
two years of service forfeits his profit sharing account balance. If he has completed
three years of service, however, he is fully
vested and receives his entire profit sharing
account balance. Years of service for vesting purposes are determined on a plan year
basis. An employee working forty hours per
week would complete one thousand hours
of service by mid- June of a calendar year,
so if he quit in July with two prior years of
vesting service he would be fully vested.
With a six-year staggered vesting schedule, an employee takes six years to become
fully vested. If he quits with four years of service he would be 60% vested. As a general
rule I recommend a six-year staggered vesting schedule under the theory that it helps
reduce turnover, but my recommendation
will generally be based upon the sponsor’s
historic turnover. A plan may disregard service prior to the plan being implemented,
and may credit service with other employers. I recommend disregarding service prior to a plan’s adoption, because prior to
a plan’s adoption adequate records might
not have been kept as to hours of service.
Allocation Formulas
Your father’s retirement plan had a simple allocation formula. Contributions were
either allocated (1) in the ratio of compensation (a pro rata formula) or (2) in two separate allocations, one based on total compensation and a second based on compensation in excess of the taxable