Employers of all types and sizes continue to sponsor 401(k) plans to attract job candidates and help employees save for retirement. Sure, there are other types of qualified plans to consider, but the 401(k) is popular for a reason — it’s a powerful savings vehicle with tax advantages for both the plan sponsor and participants.
However, if your organization sponsors one, you know 401(k)s are heavily regulated. Among the most important compliance areas to stay on top of is precisely when employees become eligible to participate.
Basics of the rules
In the simplest terms, 401(k) plan eligibility depends on two factors: age and service time. You must, under federal law, allow full-time employees to participate in your plan if:
- They’re at least 21 years old, and
- They’ve completed one year of service time, which is generally defined as 1,000 hours during the 12-month period starting on an employee’s hire date.
You may design your plan with more generous terms — even allowing new hires immediate eligibility — but you can’t impose stricter requirements.
The rules for part-time employees are slightly different. They must still meet the age requirement, but the service time requirement is 500 hours per year for two consecutive plan years. The two-year rule took effect in 2025; it applies to part-time employees who worked at least 500 hours in both 2023 and 2024. Previously, it had been three consecutive plan years.
Important: The rules for part-timers changed under the SECURE Act of 2019 and its follow-up law, SECURE 2.0. Although these laws broadened access to 401(k)s for more workers, they added tracking and administrative complexity for employer-sponsors.
Risks to consider
Organizations that employ a relatively simple, stable workforce of full-time employees probably won’t have too much trouble complying with the eligibility rules. However, employers with part-time, seasonal and variable-hour staff can get tripped up fairly easily. If your organization has changed its approach to hiring and staffing recently, you may be particularly at risk.
Misunderstanding or inadvertently ignoring the eligibility rules and excluding an eligible employee from your 401(k) can have real-world consequences. For starters, the IRS may audit your plan, which is a stressful and time-consuming process.
Your organization could face financial penalties if the tax agency can prove that rule violations occurred. You may also be required to make retroactive contributions representing a percentage of the employee’s missed deferrals (often 50%) plus estimated investment gains. In extreme cases, the IRS may disqualify your plan, causing it to lose its tax-advantaged status.
How to protect your organization
So, how can your organization protect itself from violations? You’ll need to do more than just check each employee’s hire date. For every staff member, consistently track hours worked and set up verification measures to ensure compliance with eligibility rules.
If you self-administer, your payroll software or human resources information system platform may be of great help. In the event you use a third-party administrator, that provider should be able to assist you or, ideally, offer eligibility tracking as a service.
Also, work with your benefits attorney or advisor to understand how breaks in service affect eligibility. Keep a close eye on potential rule changes, too. No further revisions are scheduled under SECURE 2.0, but future legislation could modify the rules again.
Strategic investment
Assuming you’ve implemented one, your 401(k) plan is a strategic investment in your employees’ financial security, as well as in remaining a competitive force in the job market. Granted, there are many rules and administrative requirements, but they’re manageable.
To that end, contact us for help. We can review your plan design, compliance processes and costs, as well as assist you in catching potential errors and maximizing the value of this fringe benefit.
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