The IRS recently considered this key issue regarding a 401(k) plan participant’s vesting when there are breaks in service.
Here is the case: A 401(k) plan uses a six-year graded vesting schedule for matching contributions, and forfeits the nonvested portion in a terminated participant’s matching contribution account after a cash-out or five consecutive one-year breaks in service.
Recently the company rehired, on a full-time basis, a former employee who had two years of vesting service when he was cashed out in 2008. When he quit, he was 20 percent vested in his matching contribution account, and during his absence, he accrued three consecutive one-year breaks in service. Must the company give him credit for those two years of vesting service?
The IRS reasoned that because the employee was rehired prior to having five consecutive one-year breaks in service, his two pre-break years of service must be counted for vesting of his matching contribution account. If he repays the entire amount of the distribution, the amount forfeited when he was cashed out will be restored.
Break in Service Rule
Under the plan, participants had a one-year break in service for any year in which they did not complete the minimum hours of service required by the plan’s terms (for example, 501 hours).
The plan also used the special break-in-service rule where an employee’s post-break service is counted for vesting in pre-break accounts only if the employee is rehired prior to having five consecutive one-year breaks in service.