More HH Legal Updates

New laws require employers maintaining 401(k) plans to allow participation by “long-term, part time employees” (“LTPTEs”) starting in 2024.  On Black Friday (November 24, 2023), the Treasury Department and IRS issued regulations detailing how these rules are to be applied.  Although the new regulations are just “proposed” regulations, they provide that plan sponsors can rely on them until such time as they are finalized.  Therefore, these are the rules that employers should follow unless and until further guidance is issued.  Employers now need to act quickly to make sure that their plans comply with the rules as the new year arrives.    

Background.

Historically, 401(k) plans were permitted to impose an eligibility requirement of one year of service, defined to require 1,000 hours of service in a 12-month period, forever excluding part-time employees who never satisfied this requirement.  In the interest of expanding employee access to employer-sponsored retirement savings vehicles, the original SECURE Act passed in 2019 included a new rule requiring eligibility for part-time employees who complete at least 500 hours of service in each of 3 consecutive years, although that eligibility can be limited to the 401(k) component of the plan (i.e., no employer contributions for these employees are required).  Since pre-2021 service was not required to be counted, the practical effective date of the 2019 SECURE Act change was January 1, 2024.  The SECURE 2.0 law passed in 2022 reduced the 3 year requirement to 2 years, effective January 1, 2025.

Although the LTPTE rules seem simple at first glance, there are a number of nuances in the application of the rules, and several questions left unanswered by the text of the SECURE and SECURE 2.0 laws.  The new regulations are intended to fill those holes, and are summarized below:

Definition of “Long-Term, Part-Time Employee.” 

Neither the 2019 SECURE Act nor the 2022 SECURE 2.0 law define the term “long-term, part-time employee.”  The approach taken by the new regulations in defining the term could lead to confusion if not fully understood.  The regulations provide that an employee is an LTPTE only if the employee becomes a participant in the plan solely because of the LTPTE rules.  As an example, many plans provide for an eligibility requirement considerably more liberal than the permitted one year of service, such as eligibility after 90 days of employment, or immediate eligibility upon date of hire.  In those cases, an employee might have completed 500 hours in each of 3 (or 2) consecutive years (the LTPTE requirements), but because the employee will have already entered the plan under the 90-day or immediate eligibility provision, that employee will not be an LTPTE.  In fact, if a plan provides for 90-day or immediate eligibility, there can be no LTPTEs in the plan, and therefore none of the special LTPTE rules will apply. 

In addition to a definition of the term “long-term, part-time employee,” the regulations introduce a new, related term – “former long-term part-time employee” (“Former LTPTE”).  An LTPTE becomes a Former LTPTE when the LTPTE works more than 1,000 hours, after having initially entered the plan as an LTPTE, and thereby satisfies the eligibility requirements to become a “regular” plan participant.  Once an employee becomes a Former LTPTE, that employee can never again be a LTPTE, which means that most of the rules applicable to LTPTEs will never again apply to that employee.  The sole exception is the vesting rules (discussed further below). 

Class Exclusions. 

Traditionally, a 401(k) plan has been permitted to exclude objective classifications of employees from participation in the plan, provided that such exclusions did not cause the plan to fail the minimum coverage requirements imposed by Section 410(b) of the Internal Revenue Code.  Under these rules, for example, a plan could potentially be written to exclude employees paid on an hourly basis, employees employed at a particular location, and/or employees with particular job titles. 

A key question was whether these historically-permitted exclusions would be overridden by the LTPTE rules.  Fortunately, the answer to this question is no.  The new regulations confirm that plans that have excluded particular classifications of employees in the past can continue to do so.  A critical caveat, however, is that class exclusions cannot be “disguised” service requirements, i.e., requirements based on how much an employee works, as opposed to the type of services they perform, how they are paid, etc.  This concept is not new, however, as even pre-SECURE rules generally prohibited class exclusions such as “part-time” employees, “temporary” employees, and “casual employees.”  (Technically, these types of exclusions were permitted if the plan contained “fail-safe” language admitting the employees to participation if they in fact completed 1,000 hours in a 12-month period.)  However, these types of exclusions cannot be used to avoid the LTPTE rules, and the IRS will no doubt be looking for class exclusions that are disguised service requirements.

Eligibility Computation Periods and Entry Dates. 

Fortunately, the new regulations confirm that the rules concerning the measuring periods used to determine whether an employee satisfies the 3-year requirement (or 2-year requirement starting in 2025) are essentially the same as the current rules applicable to a plan with a one-year service requirement.  In all cases, the employee’s first measuring period is the 12-month period beginning on the employee’s date of hire.  After that, measuring periods can either (a) commence on each anniversary of the date of hire, or (b) switch to the plan year (beginning with the plan year that includes the employee’s first anniversary).  The switch to the plan year provides for uniformity among employees’ measuring periods (after the first), but also requires that some hours be counted twice (as some hours will be included in both the 12-month period beginning on date of hire and the first post-switch plan year).  

The entry date rules are also similar to current requirements.  After completion of the 3-year requirement (or 2-year requirement starting in 2025), an LTPTE must be permitted to begin 401(k) contributions as of the next entry date which is not less frequent than semi-annual (e.g., January 1 or July 1 for a calendar year plan).

Vesting.

If an LTPTE never becomes eligible to receive employer contributions under a plan, vesting is a moot point.  However, an LTPTE could eventually work enough hours to become a “regular” plan participant eligible to share in employer contributions such as matching contributions.  Also, although not required to make employer contributions for LTPTEs, employers are permitted to do so.  For these reasons, vesting of LTPTEs can be relevant.  The vesting rules applicable to LTPTEs are essentially the same as those applicable to other plan participants, with two exceptions:  (a) years prior to January 1, 2021 are not counted, and (b) an LTPTE only has to work 500 hours during a year to receive credit for that year.  One potential oddity of the new regulations is an employee who first enters the plan as an LTPTE will forever have the employee’s vesting determined based on 500 hours per year, even if the employee subsequently works enough hours to become a “regular” participant.  In this regard, an LTPTE could actually end up being treated more favorably than an employee who completed a year of service (with 1,000 hours) and thereby originally joined the plan as a regular, non-LTPTE participant.

403(b) Plans. 

Although 403(b) plans maintained by tax-exempt employers are not subject to the 2019 SECURE Act LTPTE requirements, the 2022 SECURE 2.0 law extended application of the LTPTE rules to 403(b) plans that are subject to ERISA, effective for plan years beginning after December 31, 2024.  Sponsors of 403(b) plans therefore have one more year before they need to worry about these rules, and the new regulations do not apply to them.  As similar rules are expected for 403(b) plans, however, sponsors of these plans should become familiar with the rules and be prepared to apply them beginning in 2025.

Plan Amendments and Operational Compliance.

Plan amendments to comply with all applicable requirements of both the SECURE and SECURE 2.0 laws are not required until the end of the plan year beginning in 2025.  The new LTPTE regulations did not change this deadline, and therefore employers (and plan document providers) will most likely wait until 2025 to prepare and adopt comprehensive amendments reflecting all SECURE and SECURE 2.0 requirements. 

In the meantime, operational compliance is required.  Therefore, employers should use the last several weeks of 2023 to (a) determine whether they have any employees who will qualify as LTPTEs effective January 1, 2024, and (b) make sure that any such employees are in fact offered the opportunity to commence 401(k) contributions at that time.

The above summary does not cover all aspects of the new regulations, but is intended to address those points in which employers will be most interested.  Please contact Gary Gunnett at (412) 288-2210 or ggunnett@hh-law.com with any questions.