Guidance Needed on 1-Year Holdout Rule Elective Deferrals

Guidance Needed on 1-Year Holdout Rule Elective Deferrals

When an employee is rehired by a company, the granting or vesting of benefits under certain retirement plans may be delayed until the employee has been re-employed for a period of at least one year.  The applicability of this "Holdout Rule" is becoming more common as the economy makes a recovery and former employees are targeted for rehiring.

Under the Holdout Rule, if an employee's term of service is disrupted by at least a year, a company's qualified retirement plan may disregard the previous service temporarily.  After an additional year of service, credit for the prior service is restored retroactively, with consideration added for the service since the date of rehire.  

What is unclear to date, though, is how to handle the elective deferrals and employer contributions to qualified retirement plans like 401(k) plans when there is retroactive treatment.  Organizations like the American Society of Pension Professionals and Actuaries (ASPPA) are  urging the IRS to issue guidance regarding pension eligibility when a former employee is rehired following a one-year break in service (see "Pension Professionals Seeks Guidance on 'Holdout' Rule," taxanalysts® Tax Notes Today, November 28, 2012).  Informally, the IRS has said that the one-year holdout rule cannot be used for purposes of elective deferrals to 401(k) plans, simply because deferrals can't be done retroactively.  The ASPPA argues that this seems contrary to both the Internal Revenue Code and congressional intent, and has suggested two approaches that may be implemented in connection with defined contribution plans, especially profit-sharing plans.

Although the One-Year Holdout Rule was implemented before 401(k) and similar deferred compensation plans became popular, the qualified retirement plan rules have been addressed and updated by Congress many times, and the rule has not been repealed or specifically limited to plans other than 401(k) plans.  With the frequency of issues related to elective deferrals and the Holdout Rule increasing, the time is ripe for further guidance on elective deferrals under this rule. In the interim, "break-in service" provisions, not previously common in plans, may be effective to address these issues involving elective deferrals.

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