Retirement plan changes for long-term, part-time employees

This article has been updated for the LTPT proposed regulations amending Treas. Reg. section 1.401(k)-5 and issued by the IRS on Nov. 24, 2023. The regulations are effective for plan years beginning on or after Jan. 1, 2024, and can be relied upon until other guidance is provided.

The Internal Revenue Code (the Code) has historically allowed employers to exclude employees who never worked at least 1,000 hours in a 12-month period from an employer sponsored retirement plan. Because of this, part-time employees who never reach this threshold often miss out on an opportunity to set aside money for retirement. Such employees include individuals who have limited time to devote to work, such as parents, caregivers, and students. Additionally, some people have multiple part-time jobs, due to a need for flexibility. Based on data from the Bureau of Labor Statistics, there were close to 25.5 million people working part-time in 2021.

Congress has long been concerned about increasing retirement savings for individuals and included changes to the Code to benefit long-term, part-time (LTPT) employees with the Setting Every Community Up for Retirement Enhancement Act (SECURE 1.0). In short, effective in 2024, SECURE 1.0 requires that 401(k) plans allow employees with at least 500 hours of service in three consecutive 12-month periods to contribute elective deferrals to the plan.

The SECURE 2.0 Act of 2022 (SECURE 2.0), brought forth enhancements to Secure 1.0’s LTPT provisions, effective for plan years beginning after Dec. 31, 2024, which furthers the goal for more individuals to have retirement savings. The 401(k) plan requirement to allow employees to contribute elective deferrals was expanded to 403(b) plans and the period of service was reduced from three to two consecutive 12-month periods. SECURE 2.0 also added clarity to changes made by SECURE 1.0.

401(k) plan sponsors may believe the SECURE 2.0 provisions override SECURE 1.0 and that they do not need to act until 2025. This is not the case. Employers, plan sponsors, and third-party administrators need to understand how plan operations will be affected for plan years beginning in 2024 and what they must do now to be prepared for the changes. They also should be cognizant that the IRS will likely issue additional guidance on these provisions.

Summarized below is a discussion of how the SECURE 1.0 and 2.0 LTPT provisions apply to retirement plan operations. It should be noted that collectively bargained employees and non-resident aliens with no U.S. source income are excluded from the LTPT provisions.

401(k) plans

Plan eligibility

For plan years beginning in 2024, if an employee has three consecutive 12-month periods with at least 500 hours of service in each, the employee must be eligible to contribute elective deferrals to the plan. Periods beginning prior to Jan. 1, 2021, are not considered when determining eligibility; therefore, 2024 is the first possible year LTPT employees must be allowed to participate in a 401(k) plan for purposes of elective deferrals. An employee’s initial 12-month period ends on their first anniversary date of employment. Subsequent periods can continue to be based on the employee’s anniversary year of employment or can switch to the plan year. The LTPT employee rules apply to employees who are at least age 21.

For plan years beginning in 2025, the employee needs only two consecutive 12-month periods with at least 500 hours of service in each to be allowed to participate.

One aspect stressed multiple times in the proposed regulations is that the LTPT rules only apply if the sole reason an employee is eligible to defer is because of the LTPT eligibility conditions (age 21 and consecutive 12-month periods of employment with at least 500 hours of service). Several examples are included in the regulations demonstrating when an employee is a LTPT employee. For example, if an employee is eligible to defer because the plan provides for immediate plan entry upon employment, the employee is not a LTPT employee.

Excluded classes of employees

The proposed regulations also confirmed that an employee, who otherwise would be a LTPT, can be excluded from the plan if they are part of an excluded employee class. However, the definition of the employee class cannot be a proxy for a service or age requirement.

Former LTPT employees

Another concept addressed is that of a former LTPT employee. A LTPT employee who later satisfies the plan’s eligibility conditions (e.g., 1,000 hours in a plan year), becomes a former LTPT as of the first day of the plan year after satisfaction of the requirements. The employee will never again be considered a LTPT and the LTPT rules do not apply to them, except for how a year of vesting service is determined. The vesting treatment is discussed later in this article.

A LTPT employee also becomes a former LTPT employee when they shift to an ineligible class. At which point, the former LTPT can no longer defer to the plan and is treated as an ineligible employee in every respect. They will continue to earn vesting credit as described below. If they rejoin an eligible employee class, they again become subject to the LTPT rules, assuming they did not satisfy the plan’s regular eligibility conditions in the interim.

Top heavy rules

Plans that are top heavy must satisfy minimum contribution and vesting requirements. An employer can elect to exclude the LTPT employees from these requirements.

A defined contribution plan is a top-heavy plan if the aggregate of the accounts of key employees exceeds 60 percent of the aggregate of the accounts of all employees under the plan.

In determining whether the plan is top heavy, it will not be considered top heavy merely because employer contributions are not made to LTPT employees.

The proposed regulations clarified that while LTPT employees are not required to receive a top-heavy minimum contribution, the balances of LTPT employees are included in the determination of whether the plan is top heavy.

403(b) Plans subject to ERISA

Plan eligibility

The first year a 403(b) plan must allow a LTPT employee to enter the plan is 2025. For plan years beginning in 2025, an employee must have two consecutive 12-month periods with at least 500 hours of service in each. Periods beginning before January 1, 2023, will not be taken into account when determining if the employee has satisfied the two consecutive 12-month periods requirement. Consistent with 401(k) plans, the employee must be at least age 21.

403(b) plans are subject to the universal availability rules and there are employee exclusions unique to these plans. For example, students enrolled in and working at a school can be excluded from participating in the school’s 403(b) plan. The LTPT provisions will likely result in some students being eligible for the plan. However, we expect additional guidance to be released on how these LTPT requirements will interact with the universal availability rules.

Guidance specific to 403(b) plans was not included in the proposed regulations. Given the LTPT rules do not apply to 403(b) plans until plan years beginning in 2025, there is time for the IRS to issue additional guidance.

401(k) Plans and 403(b) Plans subject to ERISA

Employer contributions

Employers are not required to, but can, make match or nonelective contributions to LTPT employees. This includes contributions under the safe harbor 401(k) plan provisions.

Nondiscrimination testing

An employer can elect to exclude LTPT employees from nondiscrimination testing related to elective deferrals (ADP), employer match (ACP) and nonelective contributions (section 401(a)(4)). Additionally, they can be excluded from coverage testing under section 410(b).

Under the proposed regulations, LTPT employees must be included or excluded for all coverage and nondiscrimination tests (i.e., the LTPT employees cannot be included in the ADP test but excluded from the ACP test). How the LTPT employees are treated for testing purposes is separate from the decision of whether they will share in employer contributions. Just because they receive an employer contribution does not mean they have to be counted for testing purposes.

Safe harbor plans

An employer that sponsors a safe harbor 401(k) plan must specify in the plan document if it intends for the safe harbor provisions to apply to LTPT employees. These document elections are subject to the full year requirements of the 401(k) safe harbor regulations, and an employer can only change them during the plan year under limited circumstances, i.e., the mid-year change rules.

Vesting service

A LTPT employee is credited with a year of vesting service for each 12-month period the employee has at least 500 hours of service. For 401(k) plans, 12-month periods beginning prior to Jan. 1, 2021, are not counted. For 403(b) plans, periods beginning prior to Jan. 1, 2023, are not counted. If an employer chooses to make a non-safe harbor employer contribution for LTPT employees, the plan’s normal vesting schedule will apply.

The proposed regulations provide that the 500-hour rule for earning a year of vesting service continues to apply to a former LTPT. While employees who did not qualify as a LTPT and were subject to more stringent entry requirements will generally receive a year of vesting service if they work 1,000 hours during a year, current and former LTPT employees will just need 500 hours. The result being LTPT employees accrue vesting service more rapidly and there is an added layer of administrative complexity for monitoring the two different vesting methods.

Other operational considerations

There are many factors that come into play for proper administration of the LTPT provisions, including appropriate tracking of hire dates and hours worked in the employer’s HRIS or payroll system, transmission of the information to the plan’s third-party administrator and recordkeeper, and timely notification to LTPT employees of their eligibility for the plan. 401(k) plan sponsors should have already laid out a strategy for how to handle tracking of the appropriate data since periods beginning in 2021 count towards eligibility. Sponsors of 403(b) plans will now need to do the same.

Employer action steps

• Employers that will have LTPT employees should review their systems for compliance with the LTPT provisions.
  
• Consider whether you want your part-time employees to be LTPT employees. An employer can avoid the complex issues discussed above by adopting plan eligibility rules that permit all employees to enter the plan for purposes of deferral contributions either immediately upon hire or if the employer wants to impose a waiting period, have an eligibility waiting period that does not exceed 500 hours of service in a year. . This way the plan treats all employees the same, avoiding the need to identify employee as LTPT employees at all – because you will not have any.
• Determine whether you want your LTPT employees to share in some level of employer contributions and, if so, how to track hours for vesting purposes.

Conclusion

The LTPT provisions are only the tip of the iceberg when it comes to retirement plan changes brought about by SECURE 2.0. This is the perfect time for a holistic review of an employer’s retirement plan design and operations against the required changes and discretionary provisions of SECURE 2.0. In any such review, the employer should work closely with their retirement plan advisors as they need to consider if and how recordkeepers and third party administrators can accommodate their desires.