Sometimes you play a waiting game

Some companies require you to work there for a year before you can join the 401(k). Just be aware that different definitions of “year” are possible. For example, a year can mean

• Twelve months of continuous employment regardless of the number of hours worked.

• At least 1,000 hours of work during the course of 12 months of employment.

  This hours-of-service method for determining a year of service is pretty simple: The employer sets the number of hours worked before you can join the company’s 401(k) plan. That number is 1,000. So, you need to work 1,000 hours during your first 12 months of employment to be eligible to join a 401(k).

  If you don’t work 1,000 hours during your first 12 months, you can become eligible if you work at least 1,000 hours during a subsequent 12-month period.

  Most employers shift the 12-month period to a calendar year because this is an easier way to track hours worked. You need credit for a year of service to be able to join the 401(k).

  If you’re a full-time employee, you work 1,000 hours in 25 40-hour weeks. So, if you work just 20 hours a week, you get to 1,000 work hours in 50 weeks, which is within a 52-week year (just in case you weren’t paying attention).

The Secure Act passed in 2020 also requires employers to permit long-term, part-time employees to participate in 401(k) plans. These employees must work at least 500 hours in three consecutive years and be 21 or older to be eligible. Ask the human resources department for more information.

If you have to work 1,000 hours in one year to become eligible for the plan, you don’t need to work 1,000 hours in subsequent 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 vest, or become your property. (See Chapter 4 for more on matching contributions and vesting.)

Sometimes you can’t join at all

Employers are allowed to exclude certain employees from participating in the 401(k) plan. These employees include

• Union employees covered by a collective bargaining agreement: Federal law prohibits employers from offering any retirement or other benefit plan to union members that hasn’t been agreed on through collective bargaining. This includes 401(k) plans — even those funded entirely by employee contributions. Labor laws require union employees who want a 401(k) to include it in their contract demands.

  Union managers often prefer traditional defined-benefit pension plans, which guarantee benefits at retirement. This is the main reason that 401(k) coverage is lower among union employees. It’s also why 401(k) plans for union employees typically don’t include an employer matching contribution — the employer is already contributing to the defined-benefit plan.

• Nonresident aliens: Employers are allowed to exclude employees who live outside the United States and aren’t U.S. citizens from participating in the plan. However, employees who are residents of the United States (including green card holders) but are not U.S. citizens can’t be excluded simply because they’re not U.S. citizens.
• Leased employees: Leased employees are people who work for a company temporarily, often placed through an agency.

• Specific categories of employees: Under certain circumstances, an employer may exclude a specific category of employee, such as hourly workers or the employees of a specific business unit, from participating in the 401(k) plan. Generally, an employer can legally exclude a group if it makes up less than 30 percent of all employees.

  For example, your plan may permit only salaried workers to participate, and exclude hourly wage earners, if the hourly workers account for only 10 percent of the staff. However, even if the 30 percent test isn’t satisfied, a variety of other exceptions may apply. Determining the categories of employees that may be excluded can be very complicated.

  Finally, you may be excluded if you’re under 21. The exclusion has to apply to all employees under 21, though; an employer can’t permit some to participate and not others.

Sometimes you’re automatically in

Many 401(k) plans use what’s called automatic enrollment. Eligible employees are automatically signed up for the plan unless they refuse in writing. A percentage of salary is deferred into the plan for automatically enrolled employees and often is deposited in the most conservative investment option. The percentage is usually set between 3 and 6 percent by the employer and doesn’t usually go above 10 percent. Employers must follow the applicable automatic enrollment rules to receive a special tax credit available. (Head to Chapter 18 for more on employer tax credits.)

You can change your contribution percentage at any time including opting out of the plan.

The Department of Labor has designated certain funds to be Qualified Default Investments for retirement accounts. Included as a prudent investment option are Target Date Funds (TDFs) that automatically invest and rebalance for the target year — you invest in one that matches the year you turn 65. A TDF is a balanced fund with a mix of stock and bond funds.

Your 401(k) plan may also permit your employer to automatically increase your contribution percentage each year. If so, you’re permitted to override such increases by providing a written request.

If your plan has automatic enrollment, make the effort to come up with an investment plan to diversify your money among different investments. (A TDF is diversified from the get-go, so you don’t need to seek diversity if you’re enrolled in a TDF.) Also, consider contributing more than the amount your employer automatically deducts, which is likely to be too small to build up a sufficient nest egg.