IRS provides relief for improper exclusion of part-time employees from 403(b) plan participation
On December 4, 2018, the IRS issued Notice 2018-95 to provide relief to plan sponsors who improperly excluded part-time employees from participating in their 403(b) plan.
Universal Availability Rule for 403(b) Plans
In general, pre-tax salary reduction deferrals and Roth 403(b) contributions1 are subject to the “Universal Availability Rule,” per Internal Revenue Code Section 403(b)(12)(A). The Universal Availability Rule is satisfied only if the 403(b) plan permits every eligible employee (subject to limited exceptions) to have the opportunity to make deferral contributions of at least $200 annually.
In order to satisfy the Universal Availability Rule, at least once each plan year a 403(b) plan sponsor must provide every eligible employee with a notice informing them of:
- the opportunity to make or change deferral contributions elections
- the time for making those elections
- the maximum amount permitted, and
- any additional conditions on those elections.
One of the permissible exclusions to the Universal Availability Rule is the category of employees who normally work less than 20 hours per week. If a 403(b) plan document permits this exclusion, it must apply the rule equally to all employees (known as the “consistency requirement”). In other words, a 403(b) plan sponsor is not permitted to apply the less than 20 hours per week exclusion to one group of employees, but not to another group of employees.
When the IRS issued final Section 403(b) regulations in 2007, those regulations provided additional guidance on determining whether an employee worked less than 20 hours per week. According to these final regulations, an employee is considered to work fewer than 20 hours per week only if:
- For the 12-month period beginning on the date the employee’s employment began, the employer reasonably expects the employee to work fewer than 1,000 hours of service in such period; and
- For each plan year ending after the close of the 12-month period beginning on the date the employee’s employment commenced (or, if the plan provides, each subsequent 12-month period), the employee worked fewer than 1,000 hours of service in the preceding 12-month period.
In 2013, the IRS issued Revenue Procedure 2013-22, which opened a pre-approval program for 403(b) plans and included sample language that could be leveraged by filers seeking IRS approval of a 403(b) plan document. Under this IRS pre-approved program, the IRS permitted 403(b) plan sponsors to restate their current 403(b) plan document retroactively to 2010, provided that the employer had adopted a written 403(b) plan no later than 12/31/2009. An employer adopting a pre-approved 403(b) plan document retroactively to 2010 will have reliance that the 403(b) plan document, in form, meets the requirements of Internal Revenue Code Section 403(b) and the IRS regulations.
Once in, always in
The IRS’ 403(b) sample language addressing the exclusion of part-time employees under the “fewer than 20 hours per week” rule states:
“Once an Employee becomes eligible to have Elective Deferrals made on his or her behalf under the Plan under this standard, the Employee cannot be excluded from eligibility to have Elective Deferrals made on his or her behalf in any later year under this standard.”
This means, if a 403(b) plan has this provision and an employee completes 1,000 hours of service in any year, then the employer must allow that individual to participate in the 403(b) plan in any later year, regardless of the number of hours of service that individual subsequently completes. This is known as the “once in, always in” rule. That is, the only way that an employee could be excluded as having worked “fewer than 20 hours per week” is if that employee never completed at least 1,000 hours of service in any year, known as an “exclusion year.” The following is an example:
- ABC School’s 403(b) plan document excludes employees from making elective deferrals if the employee works fewer than 20 hours per week.
- Ms. Y, a teacher at ABC school, is hired in 2014 and is not permitted to participate in the ABC 403(b) plan in 2014 since she is reasonably expected to complete less than 1,000 hours of service per year. However, in 2014, Ms. Y completes 1,050 hours of service.
- Since Ms. Y completed more than 1,000 of service in 2014, she must be permitted to make elective deferrals to the ABC 403(b) plan in all subsequent years, regardless of the number of hours she subsequently performs under the “once in, always in” rule.
- Additionally, ABC School must remember to provide Ms. Y, as an eligible employee, with the annual Universal Availability Notice informing her of the opportunity to participate in the school’s 403(b) plan.
This “once in, always in” rule took many practitioners and plan sponsors by surprise as the IRS Section 403(b) regulations were ambiguous about application of this rule in determining whether an employee met the 1,000 hour requirement in any year.
IRS Relief Provided under Notice 2018-95
IRS Notice 2018-95 provides relief to employers who may not have operated under the “once in, always in” rule. According to this Notice, a 403(b) plan with a provision to exclude employees working less than 20 hours per week will not be considered noncompliant if it did not consider such employees eligible to participate in the 403(b) plan on an ongoing basis once those employees first completed 1,000 hours of service. The Notice includes a “Relief Period” and a “Fresh Start.”
The Relief Period begins with the 2009 taxable year and ends on the last day of the exclusion year that ends before December 31, 2019. Alternative rules apply to 403(b) plans that determine whether an employee is excluded from participating in the 403(b) plan based on the employee’s anniversary date rather than a plan year. During the Relief Period, a 403(b) plan will not be treated as noncompliant if it has not operated under the “once in, always in” rule. However, relief will not be granted to a 403(b) plan that excluded an employee from participating in the 403(b) plan in a year where that employee had completed at least 1,000 hours of service in the immediate preceding year. In addition, the IRS will not grant relief in the case where a plan violated the consistency requirement.
Plan Document Language During the Relief Period
- If an employer adopts an IRS pre-approved 403(b) plan document retroactively to 2009 , the IRS will not consider the plan’s operations to be inconsistent with the terms of its plan document during the Relief Period for improperly excluding employees under the “fewer than 20 hours per week” rule. The IRS will not require the employer to amend its plan document to reflect the plan operation.
- Although the IRS does not have an approval program for individually designed 403(b) plans, the IRS notes that an individually designed plan that excludes part-time employees under the “fewer than 20 hours per week” rule and had not properly applied the “once in, always in” rule is permitted to retroactively correct by amending its plan document language to reflect the plan’s operation no later than March 31, 2020.
- After the Relief Period ends, sponsors of both IRS pre-approved 403(b) plan documents and individually designed 403(b) plans applying the “fewer than 20 hours per week” rule must ensure that their plan document properly reflects the “once in, always in” rule.
In order to take advantage of the relief, an IRS pre-approved 403(b) plan that operates its plan year on a calendar year and has the “fewer than 20 hours per week” exclusion must properly apply the “once in, always in” rule effective starting with the 2019 plan year. This means that such a 403(b) plan would need to determine if an employee performed at least 1,000 hours in any year prior to 2019. Additional rules apply to 403(b) plan who operate under a non-calendar year plan year.
Voya will continue to closely monitor this guidance and will communicate important developments as they occur.