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Break-in-service rules and returning employees

If an employee leaves your company and then you rehire him or her, this may affect the employee’s participation in your qualified retirement plan. You’ll need to determine if there was a “break in service” that impacts his or her re-entry — or initial entry — into your plan. It doesn’t matter what type of plan you sponsor because the break-in-service rules apply to all qualified retirement plans.

Defining break in service

A break in service is a 12-month period (a calendar year, plan year or other consecutive 12-month period) designated by the plan during which a plan participant completes 500 or fewer hours of service. Depending on your plan document, a break in service can occur just by reducing an employee’s hours.

You can write your plan document to limit break-in-service provisions to only participants whom you terminate from employment. Check your document or with your administrator for the specifics of your break-in-service provisions.

Completing eligibility

If you do rehire a former employee, you’ll need to determine if the employee is or was eligible to participate in your plan. First, find out if your plan has a written break-in-service provision. If not, the following rules apply:

• If the employee met your plan’s eligibility requirements and then had a break in service, he or she re-enters the plan on the re-employment date, regardless of normal entry date procedures, such as quarterly entry dates.
• If the employee didn’t meet your plan’s eligibility requirements, he or she must complete those requirements. Continuous employment isn’t required, so if you rehire the employee within one year of the original hire date, you must count all of the hours in your plan’s eligibility computation period.
• If your plan’s eligibility requirements have changed, the participant must complete the new requirements unless the plan amendment contains a “grandfather” clause. Again, if you rehire the employee within one year of the original hire date, you must count all of the hours in the eligibility computation period.

If your plan does contain break-in-service rules, verify that an actual break in service occurred according to your plan provisions. Then determine the effect this has on initial entry or re-entry into your plan. Generally, plans that include a written break-in-service provision use one of the following three types of rules:

1. One-year holdout rule. This means that prior service is temporarily disregarded until the employee completes another year of service. At that time, the plan retroactively restores entry. If your plan doesn’t have this provision, re-entry is immediate.
2. Five-year rule. This rule applies only if the employee was a plan participant when the break in service began, had a break in service of at least five years and wasn’t vested in any employer-provided money. If all are true, the employee permanently loses all prior-year service and has to start all over again as if he or she were a new employee.
3. Two-year rule. Two-year eligibility plans are uncommon. This rule applies only to plans with a two-year eligibility and employees who have a break in service before completing the two-year service requirement. If an employee has a break in service prior to completing the two-year service requirement, the employee loses credit for the prior service and must start over again as if he or she were a new employee.

Plans can determine eligibility using the “counting hours” or “elapsed time” method. If you use the counting hours method, you determine a break in service by the hours of service credited. If you use the elapsed time method, you determine a break in service by the length of severance.

Vesting makes a difference

If the plan credits an employee with 1,000 hours or more of service during a plan year in which his or her employment terminates, the plan must credit the employee with another year of service and, therefore, another year of vesting in the plan. You may need to credit the employee for hours of service for compensation paid to the terminated employee. For example, if the employee had two weeks of accrued vacation owed to him or her, you must add an additional 80 hours of service to the actual hours worked.

This can impact whether an employee receives credit for another year of service and thus another year of vesting. Also, nonvested hours aren’t always automatically forfeited simply because of termination. Check your plan document or contact your plan administrator to find out more.

Breaking up

Rehiring an employee can be great for your company.  But when your retirement plan is involved, it involves more than just saying “Welcome back.” Contact your plan administrator or sponsor if you have questions. •

What happens when an employee takes a leave of absence?

A break in service isn’t the same as an “interruption” of service. Employers must credit service for the following leave:

Maternity/paternity leave. You must credit employees for paid hours during a maternity or paternity leave as normal hours of service. However, you can credit unpaid hours to the employee for the number of hours during the absence (up to a maximum of 501 hours). The unpaid hours you credit to the employee are used only to determine a break in service. You don’t have to count them toward earning a year of service.

Family and Medical Leave Act (FMLA). Most FMLA leaves are unpaid. Because FMLA lasts only up to 12 weeks, most employees will have enough hours to prevent a break in service. But you must credit the hours for the leave if they’re needed to prevent a break in service. If the employee is paid for the leave, the normal crediting of hours applies.

Military service. Employers must treat military service as continuous service when determining the employee’s right to accrue benefits under the plan. Therefore, break-in-service rules don’t apply to military leaves.