Understanding the Rules for Participating in a 401(k) Plan, Beneficiary Appointment, 401(k) Plans for High Paid Employees

(July 15th, 2009)

Self-employed business people or those employees whose employer’s do not offer a retirement plan sometimes want to know how they can “open a 401k account.” Unfortunately, it is not very simple and unlike an Individual Retirement Account (IRA) where you can open your own IRA account, a 401(k) is only available through your employer. Organizations are not required by law to offer 401(k) or any other retirement plans for that matter, but they do it just to attract and retain good talent. Also, just because your employer offers a 401(k) plan does not mean you are automatically eligible for contributions. Before joining your employer’s 401(k) plan, you must meet the eligibility requirements.
If you meet the eligibility requirements and do join the 401(k) plan, you will have to make decisions on how much to contribute from each pay check and how your contributions will be invested as well as who will inherit your account if you die (beneficiary).

401(k) Eligibility – Can you participate and Contribute to your Employer’s 401(k)?

Your employer is not required to let all employees participate in the 401(k) immediately; there may be a vesting period. Also, certain groups of employees may be excluded altogether. When you interview for a job position, ask whether the employer offers a 401(k) and what will make you eligible to contribute. As a new hire, you may be able to participate immediately or you may have to wait one year before you are eligible to join the plan. However, sometimes you may never be eligible to contribute to the plan, therefore it is important to ask your Human Resources department for eligibility requirements for 401(k) plan participation.

Once you meet the requirements, you may have to wait until the plan’s next entry date to actually begin contributing to the account. The entry date is the first date you can actually contribute to a 401(k) plan after satisfying the eligibility requirements. Some employers have a plan entry date every pay period, while others may have it only once a year, or several times a year; check your plan rules. You should preferably take up a job with a company that lets you join their 401(k) plan shortly after hire; however you may not always have this at your leisure.

If you have to work 1000 hours in one year to become eligible for the plan, you generally do not need to work another 1000 hours in the following years to remain in the plan. However, the number of hours you work in subsequent years may affect your eligibility to receive employer contributions. It may also affect how soon those contributions are vested and become 100% yours.

Exclusion from Contributing to 401(k) Plans

Sometimes employers are allowed to exclude certain employees from participating in their 401(k) plan altogether. Examples of such employees include:

i) Union employees protected by a collective bargaining agreement – The federal government prohibits any companies from offering employer 401(k) plans to any union employees that haven’t been agreed through a collective bargaining agreement. This also includes 401(k) plans. The US Department of Labour requires union employees who want a 401(k) to include it in their contract demands, and final employment contract agreements. Most union managers prefer to get traditional defined-benefit pension plans as opposed to 401(k) plans because defined-benefit pension plans guarantee a specified annuity upon retirement. This is the main reason why 401(k) plans are not very popular among employee unions. Also, most 401(k) plans for union employees do not contain employer matches because the employer is already contributing to their defined-benefit plan.

ii) Non-resident Employees – Employees who live outside the US and are not US citizens are excluded from participating in the plan. However, employees who are residents of the US but not citizens cannot be excluded from 401(k) plans (this also includes those who hold green cards).

iii) Temporary (Leased) Employees – Temporary workers in an organization leased or put in place through an agency are not eligible to participate in that company’s 401(k) plans and usually are not offered the health & dental benefits that are offered to full time workers.

iv) Specific groups of employees – Some times, an employer may exclude a specific group of employees from participating in 401(k) plans, examples include hourly and temporary workers, employees of a specific business division, employees under 21 years of age, etc. If a certain group of employees makes up less than 30% of its total workforce, the company may legally exclude this group from participating in company 401(k) plan. Some companies allow only salaried workers to participate in their 401(k) plan, thus excluding hourly paid workers.

Automatic 401(k) Enrolments

Some companies will automatically enrol you in their 401(k) plans unless you send a refusal letter in writing. This is known as automatic enrolment and a percentage of your salary will be contributed to the retirement plan in biweekly payroll deductions. Most of the times, the company has a selection of investments for you to choose from. You have to sometimes contribute a little more than what your employer deducts to make the 401(k) retirement saving more worthwhile, as the amounts deducted may not be sufficient upon retirement.