Many employers wish to exclude part-time employees from participation in their 401(k) plans. This is generally due to the fluid nature of part-time employment and the relatively small account balances that result. Both of these factors can add to disproportionate administrative costs and burdens. In addition, employers may want to reward full-time employees with benefits not afforded to part-time workers. However, part-time employees may not be excluded from participation as a category. Code Section 410(a)(1) generally provides that the maximum service an employer can require of an employee in order to participate in a 401(k) plan is 1,000 hours in a 12-month period. The Internal Revenue Service has said that the wholesale exclusion of part-time employees would violate the maximum hours of service limit because a part-time employee could complete more than 1,000 hours in 12 months and would still be excluded. See Treasury Regulations Section 1.410(a)-3(e)(2), Example (3). While an employer may exclude categories of employees, the exclusion of part-time employees is based on number of hours worked, so the category inherently violates the maximum service requirement. As a result, many employers require the completion of 1,000 hours of service in a 12-month period in order to participate in their 401(k) plan. This effectively excludes most, if not all, part-time employees, who generally will not complete that many hours of service in any 12-month period.
Under new Code Section 401(k)(15), added by the Setting Every Community Up for Retirement Enhancement Act of 2019, known as the SECURE Act, certain long-term part-time employees will soon be eligible to participate in their employers’ 401(k) plans, even where the plan provides for the maximum service requirements in general. Note that this applies to only 401(k) plans not to 403(b) plans.
These new eligibility provisions only apply to employees who complete at least 500 hours in three consecutive 12-month periods (“Eligible Part-Time Employees”). Accordingly, if a plan provides for a service requirement of 1,000 hours in a 12-month period, and an employee completes 600 hours in three consecutive 12-month periods, the employee would be an Eligible Part-Time Employee even though he or she never completed 1,000 hours in any of those 12-month periods.
Eligible Part-Time Employees will be able to make deferrals into the 401(k) plan, but will not be eligible for the employer contribution until the employee otherwise meets the eligibility conditions of the plan (e.g., 1,000 hours of service in 12 months). In the example above, the Eligible Part-Time Employee would be eligible to make deferrals into the plan, but would not be eligible for any matching contribution attributable to those deferrals until and unless the employee meets the 1,000 hours of service in 12 months criteria.
The 12-month periods of service will not be counted for determining whether a part-time employee is an Eligible Part-Time Employee until periods beginning after December 31, 2020, which means that the first entry dates will be in 2024.
Having an eligibility requirement of 1,000 hours of service in 12months will still effectively eliminate most part-time employees. However part-time employees who have been working for an employer for an extended period may now benefit from tax deferrals in their employer’s 401(k) plan. Employers who currently have eligibility service requirements will want to evaluate whether this new requirement will affect them. If it will, the employer has the following options to consider:
Remove the service requirement for deferral purposes and open up eligibility for deferrals (and matching contributions, if any) to all employees effective no later than the 2024 plan year. This option is more administratively simple but will be more generous than required by the new law; or
Limit compliance to the minimum requirements, which will entail:
Updating administrative procedures and service tracking systems to begin tracking part-time employee hours of service in excess of 500 hours beginning January 1, 2021
Preparing to enroll Eligible Part-Time Employees in deferrals beginning in 2024
Updating systems to specially track the deferrals of these Eligible Part-Time Employees in order to exclude them from matching contributions (until and unless they otherwise meet the eligibility requirements of the plan), as they are being treated differently than other deferring participants, unless the employer wishes to simplify administration by matching the deferrals of Eligible Part-Time Employees like other participants.
Any required amendments must be adopted no later than the end of the plan year beginning on or after January 1, 2022 (January 1, 2024 for collectively bargained and governmental plans). Stay tuned as there will likely be additional guidance from the Internal Revenue Service regarding this change. In the meantime, employers should begin analyzing their plan provisions as soon as possible so a plan of compliance can be formulated and administrative and plan document revisions can be set in place before the coming deadlines. Boutwell Fay attorneys are available to assist you in this process or answer any questions you may have.
© Boutwell Fay LLP 2020, All Rights Reserved.This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us.The information contained in this article is effective as of February 29, 2020.