At the end of 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law. Among the many sweeping changes within the Act, it altered eligibility requirements for part-time employees for 401(k) plans.
Effective in 2024, 401(k) plans must allow an employee who works at least 500 hours of service per year for three consecutive years to become eligible to join the plan for purposes of making 401(k) contributions. The Act refers to these employees as long-term part-time employees. The Act specifies that the employer is not required to provide matching or profit-sharing contributions to these employees, even if the plan is top-heavy. Employee service before January 1, 2021 can be disregarded for this purpose, so 2021 is the first year an employee’s part-time service must be tracked for this new requirement.
Retirement plans with employer contributions subject to vesting schedules require a year of service often defined as having at least 1,000 hours of service during the year for each year of vesting credit. Since the passing of the Act, the IRS clarified that if a long-term part-time employee becomes eligible for a matching or profit-sharing contribution subject to vesting, the years that they worked at least 500 hours of service would count for vesting credit. In addition, the IRS indicated that years prior to 2021 where the employee worked at least 500 hours of service would also be included for vesting credit.
Plan sponsors with no service requirements for eligibility for employer contribution allocation purposes may wish to reevaluate those provisions to exclude long-term part-time employees from receiving these contributions. If a long-term part-time employee later works 1,000 hours of service or more per year and therefore becomes eligible for employer contributions, their prior years with 500 hours of service will still count for determining their vested interest in such employer contributions.
Retirement plan practitioners commented to the IRS that the SECURE Act’s impact on vesting is unduly complicated and should be changed. So far, the IRS and more recent legislation has not changed any part of the vesting requirements in the Act. Currently, there is a proposed Secure Act 2.0 in Congress that would change the three-year eligibility requirement to two years but remains silent on the vesting issue.
Tracking Service Hours
Employers that do not track service hours for these long-term part-time employees may want to start doing so. Most retirement plans include language that uses an equivalency based on days, weeks, or months worked to determine the number of hours when actual hours are not tracked. This could make an employee eligible even if they don’t work the required 500 hours during the year because the equivalencies may exceed the actual hours these employees work.
An issue that still requires clarification from the IRS impacts plans that exclude certain classifications of employees subject to coverage testing, either by job title, location, or other criteria. It is unknown if these employers must allow employees within the excluded class to become eligible for 401(k) deferrals if they have at least 500 hours of service for three years in a row. However, certain statutory exclusions—for example, employees subject to a collective bargaining agreement—are not impacted by the long-term part-time employee rule and may still be excluded.
Looking Ahead with Aldrich
Some plans might end up with over 120 participants in 2024 when long-term part-time employees are required to become eligible. If this happens, the plan will become subject to a required annual audit. It would be possible to establish a separate plan for the long-term part-time employees to avoid this outcome. However, changes need to be made prior to 2024 to avoid the issue.
If you have questions about the requirement to include part-time employees in 401(k) plans effective in 2024, please contact your Aldrich Advisor.