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Employees Not Covered in My Plan   


What should I do if I don’t wish to cover all employees in my plan? This article explains how an Employer may exclude some employees from a qualified retirement plan. In some situations, such exclusion may be desirable or appropriate for business or other reasons. This piece also answers some of the most frequently asked questions from Employers on this topic. While the IRS is strict about these cases, we want you to be informed on the subject and to know that JULY is on your side and is here to help.


Executive Summary

A retirement plan is not required by law to cover all employees. By law, however, an employer is required to specify in advance in the Plan Document who is to be excluded. And the plan is required to pass coverage testing every year.

When should I contact JULY?

To ensure your plan document complies with your goals, you should contact JULY when your company / employer intends to:

Exclude employees or groups of employees, including part-time or seasonal employees, from your plan

Exclude PRNs, similar as-needed employees, or other employees from your plan

Exclude the employees of a related company (under common ownership)

Add, purchase, sell or remove a controlled group company (whether you wish to cover their employees or not)

Because of the “in advance” aspect of these plan document exclusions, the Best Practice is to contact JULY when you are discussing or considering exclusions such as these. With early planning you / we can avoid last minute rush signatures and unintended outcomes.

How important is timing?

Timing is everything. Because the amendment excluding employees is required to have been adopted (signed and dated) before those employees become eligible to enter the plan, timing can be critical in some cases. When acquiring another company, it can be particularly important to plan ahead before entering into final agreements or signing purchase documents.

Additional Details

The following explains in more detail the outcomes of excluding employees from your plan, including IRS consequences and penalties for non-compliance. Our intent with the detail below is to keep you informed and to let you know that we can serve as a resource and an advocate in the event your plan is non-compliant today.

Who is the Employer?

The Employer, or Plan Sponsor, is required to be identified in the plan document. Related employers include all companies, businesses, clinics, firms or practices which are members of a controlled group (under common ownership or control), or which are members of an affiliated service group. All related employers are treated as one employer for retirement plan testing purposes.

A discussion of affiliated service groups is beyond the scope of this document, but in general these are companies participating together in serving clients or in managing other companies. Please contact JULY if you would like information about affiliated service groups.

As a general rule, every Participating Employer is required to be identified in your Plan Document in advance, before its employees commence any participation in your plan. To comply with the “in advance” aspect of this requirement, you should contact JULY immediately if your Employer is considering a corporate transaction that might involve other employers, whether related or not.

Are all employees required by law to be covered in the plan?

No, the law does not require all employees in all cases to be covered in a retirement plan. Employers may have valid business reasons which may lead them to not offer retirement benefits to everyone. The law requires 1) that employers list excluded employees in their Plan Documents / Adoption Agreements and, 2) that the plan pass Coverage Testing, discussed later.

Are all employees required by the Plan Document to be covered in the plan?

Employers are required to identify excluded employees in their Plan Document or Adoption Agreement. The employer has considerable flexibility as to how to identify these employees. They may be identified as those who work for a specific division or group within the company, for a specific company within the related group of companies, or employees with a specific title or who fit within a specific job description. In some cases the employees may be excluded by name although this may limit coverage testing options. Contact JULY if you are interested in this. The exclusion must not violate anti-discrimination laws, such as excluding members of a religious, ethnic or racial group, or excluding those above a certain age.

Case Study

Clinics, hospitals and other employers in the medical field regularly employ PRNs, or as-needed employees, to fill specific positions. These employees are hired with the understanding and expectation that they are not to receive any benefits, including participation in retirement plans. When the employer lists PRNs as excluded in the Plan Document, and the Employer’s plan passes coverage testing, these employees are properly excluded, and the plan can satisfy document requirements.

If the same employer, however, used PRNs with the usual understanding they would not receive benefits, but didn’t list them as excluded in the Plan Document, these same employees would now be eligible to participate in the retirement plan. When they fulfill the plan’s eligibility and entry requirements, they would enter the plan just as any other employee would. To achieve the desired outcome, it’s important to consider in advance whether as-needed employees, or other groups of employees, should be excluded from your plan. You should ensure that your Plan Document identifies all employees who you intend to exclude from your plan. Please contact JULY if you would like to discuss this.

What about Coverage Tests?

All qualified retirement plans are required to pass coverage testing every year. This test generally requires certain percentages of non-highly compensated employees to benefit under the plan. The coverage test is one of the tests JULY provides as part of our annual Administration / Compliance Testing service. This testing is done after each year-end.

The simplest way to pass the test is for the plan to cover at least 70% of the non-highly compensated employees (generally non-owners paid below $ 115,000 in 2014 ($ 120,000 in 2015). Coverage testing can be passed using any one of several testing methods, but in general, each test requires covering minimal percentages of non-highly compensated employees. In some fact patterns, percentages which are substantially lower than the 70% figure mentioned above can pass alternate coverage tests. JULY provides testing services and automatically uses alternative coverage testing methods when needed.

When do employees become eligible to enter my plan?

Eligibility requirements are stated in plan documents and Summary Plan Descriptions (SPDs) and commonly range from immediate eligibility on the date of hire to requiring the employee to attain age 21 and to complete one year of service. The eligible employee is then required to wait until a designated entry date (often monthly, quarterly or semi-annually). You may choose the eligibility definition within the ranges allowed by law; the choice you make is required to be stated in your Plan Document and must be applied for all eligible employees.

What are the consequences if we have had a problem?

Some practitioners have stated the IRS almost takes the position that a plan document constitutes a contract between an employer and employees. These practitioners base this position on the reasoning that if employees are not excluded by terms of the plan document, they enter the plan when they meet the eligibility requirements, irrespective of any outside agreements. When IRS discovers this problem during an audit, they view it as an operational failure. In most fact patterns they require the employer to fund contributions (deemed deferral plus match, adjusted for deemed investment earnings) and typically assess substantial penalties to avoid disqualifying the plan altogether, which would be unacceptable to all parties.

Is there a better option?

If you later discover employees were excluded without provisions for this exclusion in the plan document, one option is to apply under the Voluntary Correction Program (VCP) and request retroactive IRS approval for having excluded these employees.

Will IRS agree?

VCP applications seeking to exclude employees not listed as excludable in a plan document generally need to overcome two hurdles. Some practitioners have stated the IRS starts from the presumption that the employees may not have been notified about their exclusion. And some practitioners have expressed their opinion that some IRS personnel may exhibit more concern for “the little guy” than for the employer seeking to retroactively exclude employees.

As a practical matter this is usually an uphill battle or challenge. A distinguishing consideration can be whether Employee Handbooks, 401(k) Enrollment Booklets, emails, handouts, or other documentation make it clear that specific employees had been notified and effectively knew they were not intended to be covered. With good documentation it may be possible to obtain retroactive IRS approval for excluding employees from the plan. Without good documentation IRS rulings in VCP cases have nearly always favored a requirement for the employer to fund contributions for these workers for all affected years.

What are the costs?

Two costs are usually considered when evaluating VCP. One is the requirement to fund the contribution itself plus deemed investment earnings. Because this may involve a number of employees for multiple years, this can be very substantial. The other cost to weigh is the VCP fee vs. the IRS penalty when a failure is identified on audit. VCP fees are almost always substantially cheaper than IRS penalties.

A non-cost factor is the fact that VCP tends to be more predictable and may be more controllable when compared to plans going through an IRS audit.

What do others do?

Considering all these factors, employers with good documentation for excluding employees may decide to apply under VCP based on the expectation that this approach will reduce overall costs and penalty exposure. Employers without good documentation for excluding employees may choose to apply anonymously under VCP (a “John Doe” application). Either way some practitioners believe that in some cases it may be possible to negotiate lower contributions under VCP than in an IRS audit. All employers should update Plan Documents as soon as possible to line up with intentions about any excluded employees.

What is the best outcome?

In a best case scenario outcome case, when IRS believes employees were notified of their plan exclusion, IRS issues a favorable Compliance Statement. This provides written proof for the Employer that this issue has been resolved and is protected if the IRS subsequently audits the plan or employer. There is no requirement to notify employees or for the employer to make any public record posting or statement. The significant advantage of VCP is that obtaining a favorable Compliance Statement avoids the substantially higher penalties that would be assessed if this kind of failure were to be discovered during an IRS audit along with the risk and costs of an expanded IRS audit encompassing other years or other issues.

Revenue Procedure 2013-12 requires employers who enter the Voluntary Correction Program (VCP) to pay VCP fees to the IRS. These fees start at $ 750.00 for plans with 20 or fewer participants and increase on a sliding scale based on numbers of participants in the plan. (See detailed schedule below).

Whose duty is it?

Under ERISA (the Employee Retirement Income Security Act of 1974), the Plan Administrator (commonly the Employer) is the party ultimately responsible for maintaining the plan document. When JULY is notified, we can provide whatever documents, amendments or applications may be needed.


If you would like to discuss this please contact your JULY Client Service Manager (CSM). At your request we would be glad to schedule a conference with one of our ERISA Consultants. And we recommend you consider contacting your attorney.

Schedule of VCP Fees Charged by IRS


Number of Participants


20 or fewer

$ 750.00

21 to 50

$ 1,000.00

51 to 100

$ 2,500.00

101 to 500

$ 5,000.00

501 to 1,000

$ 8,000.00

1,001 to 5,000

$ 15,000.00

5,001 to 10,000

$ 20,000.00

Over 10,000

$ 25,000.00