401(k) plan sponsors—do you need to start tracking hours for your part-time employees?
At the end of 2019, the president signed into law the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which included a number of changes to employer-sponsored retirement plans. One change involved expanding the ability of long-term, part-time employees to make 401(k) deferral contributions. While this change becomes effective in 2024, employers that apply an eligibility service requirement to determine whether employees can contribute to a 401(k) plan must begin tracking hours of service for part-time employees beginning January 1, 2021.
Generally speaking, a 401(k) plan cannot exclude employees who are at least 21 years of age and have completed 1 year of service with their employers. One year of service is commonly defined as a 12-month period during which an employee has completed 1,000 hours of service, commencing on the employee’s first day of employment. Plan sponsors may include an age and/or hours of service requirement on 401(k) plan participation, or they may decide not to impose such conditions. This flexibility allows plan sponsors to design their 401(k) plans around the specific demographics of their workforce. However, the Internal Revenue Service (IRS) has the authority to revoke a retirement plan’s tax-qualified status if the plan imposes an age requirement that exceeds 21 or a service requirement that requires more than 1,000 hours of service in a year to be eligible for the plan.
SECURE Act expansion of eligibility rules
In addition to these limitations on a plan’s minimum age and service requirements, the SECURE Act amended the Internal Revenue Code to prohibit 401(k) plans from excluding long-term, part-time employees who:
complete at least 500 hours of service for 3 consecutive 12-month periods; and
- are at least 21 years of age at the end of the 36-month period.
If these two conditions are met, the part-time employee must be eligible to make elective deferral contributions to his or her employer’s 401(k) plan. However, a plan may still exclude these participants from receiving employer contributions (i.e., matching and/or non-elective contributions) until they have met the typical 1,000 hours of service eligibility requirement.
If a plan sponsor chooses to provide employer contributions to long-term, part-time employees, then each 12-month period during which the part-time employee has attained at least 500 hours of service will be treated as 1 year of service for purposes of the plan’s vesting schedule. This 500-hour standard used to determine a year of vesting service is more generous than the 1,000-hour standard commonly used by plans to count years of service for vesting. Moreover, all years of service with the employer, except for years when an individual is under the age of 18, must be taken into account for purposes of calculating a long-term, part-time employee’s vesting schedule.
In addition to being able to continue excluding the long-term, part-time employees from employer contributions, a plan may also omit such employees from minimum coverage and nondiscrimination testing, contributions made to satisfy actual deferral percentage (ADP) and actual contribution percentage (ACP) safe harbor plan designs, and the top-heavy rules. Moreover, the new long-term, part-time employee rules do not apply to employees covered by collective bargaining agreements or employees participating in a 403(b) plan.
Unless the plan allows for immediate eligibility, the SECURE Act requires that the plan administrator track employee hours to determine eligibility to participate in the plan. To calculate the number of service hours earned over three consecutive 12-month periods leading up to the January 1, 2024, effective date, sponsors of 401(k) plans must start tracking hours of service on January 1, 2021.
This means that part-time employees who have never satisfied a plan’s 1,000 hour of service requirement will become eligible to make an elective deferral contribution to the 401(k) plan as of January 1, 2024, if they have completed 500 hours of service during each of the 3 years (i.e., 2021, 2022, and 2023) before January 1, 2024. An employer may design a plan to defer the date that an employee can become a plan participant to the earlier of: (i) the first day of the plan year after an employee satisfies the age and/or service requirement(s) or (ii) six months after an employee satisfies the age and/or service requirement(s). Therefore, plans may want to keep accurate records of hours of service to avoid an unnecessary delay in commencing plan participation, which may result in a loss of the plan’s tax-qualified status or require a correction to maintain tax qualification.
Hours of service
The issue for many plan sponsors, beginning January 1, 2021, will be how to efficiently track hours of service of part-time employees. Generally, plan sponsors may measure hours of service under one of two methods: (1) by actually counting the number of hours that an employee has worked within a 12-month period or (2) by measuring a year of service based on the total period of time that elapses while the employee is employed. The latter method is referred to as the “elapsed time” method, and it allows the plan sponsor to measure hours of service without the burden of recording each employee’s hours worked. Many plan sponsors have elected to use this method and incorporated it into the terms of the plan. Unfortunately, the SECURE Act does not mention the elapsed time method; therefore, it appears for now that plan sponsors that impose a service-based eligibility requirement on their employees will have to keep track of actual hours of service beginning January 1, 2021, at least for their part-time employees.
In conclusion, the SECURE Act will certainly enable many long-term, part-time employees to become eligible to participate in their employer’s 401(k) plan. To be prepared for this change, plan sponsors may want to review their plan documents to understand whether this provision will apply and how it may affect plan administration. Employers should also consider whether any plan design changes are required to comply with the new rule, and most importantly, they should consider implementing a system to track employees’ hours of service, starting January 1, 2021. Furthermore, plan sponsors may want to amend their plans to reflect these changes by December 31, 2022 (for calendar year plans). Taking steps now to track hours of service for the next three years will allow plan sponsors to accurately administer the SECURE Act eligibility requirement for long-time, part-time employees in 2024.
This article was written by Nash, Stewart, Ogletree, Smoak, Deakins and P.C. from National Law Review and was legally licensed through the Industry Dive publisher network. Please direct all licensing questions to [email protected].