In short, yes they are very different. Understanding the difference can be difficult because eligibility requirements and allocation conditions are often expressed similarly even though they really have no relation to one another. Eligibility refers to the requirements a new employee must meet before they can enter the plan while allocation conditions apply each plan year and are applied to determine which eligible employees will share in any employer contributions made to the plan for the plan year. The plan document will spell out these requirements.
To make matters more complex, eligibility requirements may differ for each source of contribution the plan allows for such as employee 401(k) deferrals, employer match, employer non-elective (profit sharing), etc. For example, a plan may state that a new employee must be employed for three months to be eligible to make employee deferrals. The same plan may state that a new employee must be employed for one year during which they must also work at least 1,000 hours and be at least 21 years of age to be eligible for employer profit sharing contributions.
The eligibility requirements of the plan must be met before an employee is “eligible” to enter the plan and begin making employee contributions or receiving employer contributions, but we are not done quite yet. Once a new employee satisfies the eligibility requirements for a particular contribution source, they don’t “enter” the plan until the next entry date which is also defined in the plan document. Entry dates can vary widely but are typically monthly, quarterly, or semi-annually.
Example 1: Using the plan requirements mentioned previously, Joe (age 25) is hired on a full-time basis July 15, 2015. The plan has quarterly entry dates for all contribution sources. Joe’s three-month waiting period to make 401(k) salary deferrals ends Oct. 15, 2015, but since the plan has quarterly entry dates, Joe would not be able to begin making salary deferral contributions until his 401(k) entry date which is the first day of the next quarter or Jan. 1, 2016. In addition, since his one year waiting period ends Oct. 15, 2016, Joe would not be able to begin receiving employer profit sharing contributions until the 2017 plan year since his entry date would be Jan. 1, 2017.
Once an employee has met the employer contribution source eligibility requirements and has also met their entry date, they will receive a share of employer contributions if they also meet the plan’s allocation conditions. These allocation conditions may vary by source of employer contributions (matching and/or profit sharing); however, allocation conditions cannot be applied to 401(k) salary deferrals. It is quite common for a plan to have no allocation conditions for an eligible employee to share in employer matching contributions, but require an eligible employee to work 1,000 hours during the plan year and be employed on the last day of the plan year to receive a share of the year-end employer profit sharing contributions.
Example 2: The plan mentioned above has allocation conditions of 1,000 hours and requires employment on the last day of the plan year. Based on Example 1, Joe was not eligible for the employer profit sharing portion of the plan in 2016. Even though he worked more than 1,000 hours and is employed on Dec. 31, 2016, Joe would not receive a share of any employer profit sharing contributions made for the 2016 plan year because he had not yet reached his entry date of Jan. 1, 2017. Flash forward to 2017, Joe has now entered the employer profit sharing portion of the plan and is eligible to share in those contributions, but would only receive a contribution as long as he works 1,000 hours or more in 2017 and is employed on Dec. 31, 2017. Each subsequent year, Joe must work at least 1,000 hours and be employed on the last day of the year to receive a share of the employer profit sharing contributions for that year.
– Matthew H. Slyter, QKA