Measuring Service in Pensions: Something They Didn’t Teach in Nursery School

By David J. Kupstas, FSA, EA, MSPA

David J. Kupstas, FSA, EA, MSPA

David J. Kupstas, FSA, EA, MSPA Chief Actuary

Do you remember any songs from nursery school?  I remember one that went something like this: 

"It’s time, time, time.
It’s tickety time to tell time.
And if you didn’t know what time it was,
You’d have the most horrible, simply deplorable
Tickety-tockety time."

I don’t recall for sure, but I assume the song went on to tell us about the big hand and the little hand on a clock.  The song probably was not about measuring service in qualified retirement plans.  Perhaps it should have been.  If you credit a plan participant with the wrong amount of service, you could have a most horrible – even deplorable – tickety-tockety time. 

Year of Service Equals 1,000 Hours of Service 

The first unit of time to consider in a retirement plan is the “year of service.”  The general rule is, if you earn a year of service, you’re entitled to something.  If you don’t earn a year of service, you don’t get that thing.  An employee often needs to complete a year of service before becoming eligible to participate in the plan.  Once a member of the plan, an employee may need to complete some number of years of service before he is vested in his account balance.  (Vested means you will not forfeit your account balance if you leave the company.)  Sometimes, you need to complete a year of service to be eligible to share in the contributions the company makes to the plan for that year. 

For plans we work with, a year of service usually does not simply mean 365 days.  Rather, it is based on completing a certain number of hours of service, such as 1,000.  Here are the most common plan requirements we see that are based on hours of service: 

  • Initial eligibility for the plan: An employee must complete 1,000 hours of service in the 365 days beginning on the hire date.  If the employee fails to complete 1,000 hours of service in that period, then he will become eligible after the first plan year during which he does complete 1,000 hours of service.
  • Vesting: A year of vesting service is awarded once the participant completes 1,000 hours of service in a plan year.  The plan year does not need to be finished for the participant to get credit for the vesting year.  If the employee has completed 1,000 hours of service halfway through the year, he is awarded the year of vesting service right then.
  • Contribution eligibility: A plan may require a participant to complete 1,000 hours of service during the plan year to share in employer contributions or benefits.  In a defined contribution plan, there may also be a requirement that the participant be employed at the end of the year. 

Under these rules, if an employee completes 999 hours of service, he will not have a year of service.  As soon as he completes the 1,000th hour of service, then he will have the year of service. 

A plan does not have to require 1,000 hours of service to attain a year of service.  A lower number of hours may be used, such as 500 or 750 – or one hour.  A number higher than 1,000 may not be used. 

There are other times it is important to know an employee’s hours of service.  For example, a “1-year break-in-service” occurs when an employee works fewer than 501 hours of service in a plan year.  Breaks-in-service are important to know for determining when benefits will be forfeited and whether an employee must requalify for the plan. 

Hours of Service Is Hours Worked, Plus Some and Minus Some 

Defining “hour of service” would seem to be pretty easy.  It’s an hour that you work at your job, right?  That’s part of it.  Under the regulations, hours of service include such things as vacation, holiday, illness, incapacity (including disability), layoff, jury duty, military duty or leave of absence, provided the employee is paid or entitled to be paid for the time.  Therefore, it is possible for an hour spent not working to be credited as an “hour of service.” 

While there might be a temptation to report 40 hours per week for a salaried employee, that is not how the rules work.

Some of our clients say, “I don’t know how many hours of service my employees completed.  They’re all salaried.”  While there might be a temptation in that case to report 40 hours per week worked, that is not how the rules work.  If there are employees whose hours are not tracked, the plan must use one of the following equivalencies for those employees: 

  • The days worked method: An employee will be credited with ten (10) hours of service if under the plan such employee would be credited with at least one (1) hour of service during the day.
  • The weeks worked method: An employee will be credited with forty-five (45) hours of service if under the plan such employee would be credited with at least one (1) hour of service during the week.
  • The semi-monthly payroll periods worked method: An employee will be credited with ninety-five (95) hours of service if under the plan such employee would be credited with at least one (1) hour of service during the semi-monthly payroll period.
  • Months worked method: An employee will be credited with one hundred ninety (190) hours of service if under the plan such employee would be credited with at least one (1) hour of service during the month.
  • The bi-weekly payroll periods worked method: An employee will be credited with ninety (90) hours of service if under the plan such employee would be credited with at least one (1) hour of service during the bi-weekly payroll period. 

As an example, assume the days worked method is used.  An employee would attain one year of service on the 100th day he reported to work for the year, because 100 work days times 10 hours per day equals 1,000 hours.  Under the weeks worked method, the employee would attain one year of service as soon as he started his 23rd week of work that year (23 weeks times 45 hours per week equals 1,035 hours).

The plan may use one of these equivalencies for all employees, even those for whom hours are tracked.  These equivalencies tend to be generous to employees, so most often the employer is better off using actual hours if they are available. 

Handling Employees Who Are “On Call” 

What happens when an employee is “on call?”  For example, on a given weekend a doctor might be able to go to the gym, do some yard work, attend children’s sporting events, go out to dinner, and attend worship services, but be required to leave any of these activities at a moment’s notice in case of an emergency.  How are hours credited in this case?  There is no official guidance on this subject.  The employer needs to make this determination.  It would seem some hours should be credited if the employee’s compensation reflected this on-call expectation.  Likely, the employee would be subject to one of the equivalency methods described above. 

As you can see, determining service credit in a workplace retirement plan may be a bit more than the average nursery schooler can handle.  We encourage our clients to contact us if they have questions about service crediting so that the likelihood of problems with the IRS or DOL is minimized.

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— Topics: 401(k), Retirement