The IRS issued proposed regulations on long-term, part-time employees’ eligibility to participate in 401(k) plans. The proposed regulations also address vesting and nondiscrimination requirements. The rules are proposed to apply for plan years beginning on or after January 1, 2024. Taxpayers may rely on the proposed rules prior to finalization.
Under prior law, part-time employees were not entitled to participate in a qualified cash or deferred arrangement unless they completed a year of service, generally defined to mean 1000 hours of service in a 12-month period. The SECURE Act requires employers to offer participation in 401(k) plans for long-term, part-time employees, effective for plan years beginning after 2020. Specifically, employees who earn 500 hours of service in three consecutive 12-month periods must be eligible to participate in the plan. The SECURE 2.0 Act changes the provision to provide for participation after two consecutive 12-month periods, rather than three, effective for plan years beginning after 2024.
Rules on Eligibility and Participation
The proposed regulations treat an employee as a "long-term, part-time employee" only if the employee becomes eligible to participate solely by reason of having completed 500 hours of service in three years (two years after 2024). If an employee is immediately eligible to participate under the terms of the plan, then the employee is not eligible for the special vesting and nondiscrimination rules as a long-term, part-time employee.
Similarly, the proposed regulations provide that the elapsed time method of crediting service is allowed to determine participation, but an employer who uses this method is not able to treat the employee as a long-term, part-time employee. The proposed regulations allow the general method of crediting service or an equivalency method of crediting service to determine whether an employee has completed 500 hours within a 12-month period, but the IRS will not reduce the minimum number of hours that must be credited under an equivalency method.
The proposed regulations address the latest permissible entry date for a long-term, part-time employee, how to determine 12-month periods, and other conditions on participation that plans may impose. The proposed regulations also make clear that long-term, part-time employees may be permitted to make catch-up contributions and designated Roth contributions.
The proposed regulations provide vesting rules to determine whether a long-term, part-time employee has a nonforfeitable right to employer contributions under the plan. The proposed rules generally require employers to take into account all eligible 12-month periods of service. However, to reflect the SECURE 2.0 Act, the proposed regulations permit plans to exclude any 12-month period beginning before January 1, 2021, for vesting purposes. The proposed regulations also address vesting rules for former long-term, part-time employees who subsequently complete one year of service to satisfy general eligibility rules.
Furthermore, the proposed regulations provide that neither nonelective nor matching contributions are required to be made on behalf of long-term, part-time employees. The rules address whether other rules (such as safe harbor rules, top-heavy benefit requirements, and SIMPLE 401(k) plan contributions) would require such contributions.
Nondiscrimination and coverage rules
The proposed regulations permit an employer to elect to exclude long-term, part-time employees from several nondiscrimination and minimum coverage requirements. The rules clarify that an employer election applies with respect to all long-term, part-time employees, and employers are not permitted to exclude such employees from certain testing while including them in other tests.
The proposed regulations further provide that, if an employer makes an election to exclude long-term, part-time employees from nondiscrimination tests, the plan is not deemed top-heavy merely because the employer does not make nonelective or matching contributions on behalf of such employees (or makes nonelective or matching contributions that do not satisfy safe harbor requirements). The employer election that excludes long-term part-time employees from nondiscrimination and coverage testing is separate from the employer election regarding top heavy benefits.
Please contact your Sisterson representative if you would like more information on how these changes might affect your situation.