Internal Controls Part 3: Policies and Procedures for Eligibility Determinations

This article is the third in a series about internal controls for qualified plans.Effective internal controls are essential to maintain the qualified status of a retirement plan by detecting and preventing qualification failures so that the plan sponsor can be assured that the plan is operating properly. A qualified plan must be operated consistent with the terms of the plan document or the favorable tax consequences associated with qualification are lost. This article focuses on operational compliance for eligibility and in particular the policies and procedures that an employer should establish to ensure that the group of participants actually offered participation in the plan is consistent with the plan document eligibility classification provisions.


In our prior article on eligibility classification [see Internal Controls Part 2: Operational Compliance for Eligibility Classification – Reviewing the Plan Document, June 2017, click the title to view the article], we emphasized the importance of reviewing the plan document’s eligibility provisions and listed several questions an employer should answer. Once an employer is familiar with the plan provisions relating to eligibility, the employer should set up policies and procedures that will ensure that the plan provisions are being followed.


  1. What does the recordkeeper or tpa agreement provide? Check the service agreement with the plan’s recordkeeper or third-party administrator (tpa) to determine whether and to what extent the recordkeeper or tpa is responsible for determining eligibility under the plan. Do not assume that it will be taken care of automatically by the recordkeeper. Even if the service agreement provides that the recordkeeper is responsible for determining eligibility, it is ultimately the employer’s responsibility to monitor the recordkeeper to make sure that it is making the determination accurately. Many recordkeeper service agreements will provide that the data supplied by the employer to the recordkeeper can be conclusively relied upon as being accurate and complete and that the recordkeeper has no obligation to inquire about the comprehensiveness or accuracy of the data. So, unless your service agreement provides for it, do not assume that the recordkeeper will be checking the data that you provide even if there are obvious errors in it.

  2. Which employers’ employees are covered under the plan?From the plan document, determine which employers’ employees are covered under the plan and review the payroll records of each employer. Many pre-approved plan documents provide that the employees of all members of the plans sponsor’s controlled group are automatically covered under the plan. This may require a controlled group analysis when there are related employers. Do not assume that it is better to treat the employees of all related employers as participants. If it turns out that an employer is not part of a controlled group and its employees have been impermissibly treated as participants, that will result in a qualification failure. Some plan documents provide that a related employer that adopts the plan must sign the plan document or a separate participation agreement. If the related employer fails to sign the required documents, then a plan qualification failure may occur if operationally the employer’s employees are offered participation in the plan.

  3. What do the payroll records show? Make sure that each employee on the employer’s payroll is either covered or properly excluded under an excluded class in the plan document. Check for any participants who are not reported in the payroll records. If there are participants who are not on the payroll records, determine why they are covered. For example, they may be covered as leased employees. If the plan provides that leased employees are covered under the plan, then make sure to identify those workers who satisfy the requirements for leased employee status. See Question #3 in Internal Controls Part 2: Operational Compliance for Eligibility Classification – Reviewing the Plan Document, June 2017). If the employer uses independent contractors, temporary employees or contracts for workers through a staffing firm, make sure that they are classified correctly. If they are determined to be employees of the plan sponsor, make sure they are either covered by the plan or in an excluded class. You may need to rely on Microsoft language to exclude an independent contractor who is recharacterized as an employee. See Question #4 in Internal Controls Part 2: Operational Compliance for Eligibility Classification – Reviewing the Plan Document, June 2017.

  4. Is the appropriate information being transmitted to the recordkeeper? If the recordkeeper is responsible for determining the eligibility of a newly eligible employee under the plan, make sure that there is a procedure in place for the transfer of the appropriate information to the recordkeeper. If some employees are excluded from the plan, it will not be enough to simply notify the recordkeeper of all new hires. The employer will be responsible for identifying which employees are eligible and which are not. Often this is done by coding the employer’s payroll records and then providing a payroll feed to the recordkeeper. Make sure that the person responsible for entering the codes that will classify employees as eligible fully understands the plan provisions.

  5. Does the plan have age and/or service requirements? If the plan document has an age or service eligibility requirement, then the appropriate information will need to be gathered to make the determination whether and when the requirements are met, so that eligible employees enter the plan at the proper time. When age or service requirements are imposed, determining a participant’s entry date can be tricky. Often the determination is done using software provided by the tpa or recordkeeper. If the determination is done in house, the employer should make sure that the employee responsible for making the determination fully understands the plan’s eligibility provisions. When changing to a new tpa or recordkeeper, the employer should make sure that the software used by the service provider accurately tracks the plan’s requirements.

  6. How does the plan determine service? For plans that use the counting of hours method of determining service, hours of service will need to be aggregated during the computation period provided for in the plan. If hours of service are being provided by the employer’s payroll department, the employer should check that the correct definition of hours of service (as provided in the plan document) is being used. The employer should also check that the computation period and entry date provisions are followed accurately. If the elapsed time method of determining service is provided by the plan document, then a different system will need to be established.

  7. Will an employee’s change in status affect eligibility? If the plan document provides that an employee’s change in status (for example, from hourly to salaried status) affects his or her eligibility for the plan, the employer’s procedures will need to take into account any applicable changes in status. When former employees are rehired by the employer, the employee’s status as a former employee needs to be captured and service from the employee’s prior tenure with the employer may be needed to determine his or her eligibility. Eligibility determinations requiring application of the break in service rules, for example, when an employee is hired, terminated and then re-hired, can be complicated. Employers should pay close attention to the procedures in place to deal with those situations and consult legal counsel if they have difficulty applying the rules.

  8. What procedures are in place for notifying newly eligible employees of their eligibility? Finally, employers should have procedures in place for notifying employees of their eligibility and, in the case of a 401(k) plan, for providing information on how to make elective deferrals to the plan. If an employer sponsoring a 401(k) plan fails to provide information to a newly eligible participant about how to make elective deferrals under the plan, the employee could be deemed to be impermissibly excluded from the plan. Accordingly, the employer should have procedures in place to provide notice to an employee when he or she first becomes eligible and be able to document that the procedure has been followed.

If you need assistance in reviewing your plan document or a service agreement or need help with setting up policies and procedures, you can contact any Boutwell Fay attorney.



© Boutwell Fay LLP 2017, All Rights Reserved. This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us. The information contained in this article is effective as of July 28, 2017.



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