Key Points:

• The proposed IRS regulations provide clarification on who long-term, part-time employees are and how to determine their eligibility and vesting rights.
• Long-term, part-time employees may be excluded from nondiscrimination and coverage testing, and top-heavy vesting and contributions.
• The IRS summary indicates that the long-term, part-time employee rules also apply to ERISA-exempt governmental and church plans, but the IRS is requesting comments on that issue.

The SECURE 2.0 Act of 2022 (“SECURE 2.0”) expanded on some employee benefit plan rules that were introduced in the Setting Every Community Up for Retirement Act of 2019 (“SECURE 1.0”). Prior to SECURE 1.0 and SECURE 2.0, the Internal Revenue Code (“Code”) permitted 401(k) plans to exclude part-time employees from plan participation if such employees did not work at least 1,000 hours in a year. However, section 112 of SECURE 1.0 introduced a new rule where part-time employees must be allowed to make elective contributions to a 401(k) plan so long as they work at least 500 hours, but less than 1000 hours in a year for three consecutive years. For purposes of determining eligibility under this rule, section 112 provided that any service provided prior to January 1, 2021 would be disregarded. This provision of SECURE 1.0 went into effect as of January 1, 2021, which means eligible part-time employees must now be allowed to participate in plan years beginning on or after January 1, 2024.

SECURE 2.0, among other things, reduced the three-year requirement to two years, effective January 1, 2023, for such eligible long-term, part-time employees (“LTPT Employees”). This means, for plans years beginning on or after January 1, 2025, a LTPT employee’s eligibility will only require two consecutive 12-month periods of service of at least 500 hours, but less than 1000 hours, and plans must begin counting hours to support this process as of January 1, 2023.

Because the long-term, part-time employee provisions in SECURE 1.0 and SECURE 2.0 (collectively, “LTPT Rules”) for the most part amended provisions in the Code and the Employee Retirement Income Security Act of 1974 (“ERISA”) that do not apply to governmental plans, many employee benefits practitioners believed that the LTPT Rules would apply to ERISA-covered plans only, and not to governmental or church plans, which are exempt from ERISA and most of the participation and vesting requirements of the Code.

On November 24, 2023, the IRS issued proposed regulations regarding LTPT Rules under Code section 401(k). Like many others, we were surprised when the IRS stated in the introduction summary of the proposed rules that for purposes of the LTPT Rules, Code section 411 will be treated "as if it applies" to governmental and church plans as well. However, the IRS requested public comments on implications of the application of LTPT Rules to governmental and church plans. The deadline to submit comments to the proposed regulations was January 26, 2024 and the public hearing on comments is scheduled for March 15, 2024.

Hanson Bridgett submitted comments reflecting concerns of its public entity clients that the existing payroll and benefits systems of many public entities cannot accommodate tracking the information required under the new LTPT Rules without significant adjustments that will be time-consuming and may impose a significant financial burden for these plans, where such expenses often fall on the participants. If these provisions become applicable to governmental plans, our comments urged the IRS to consider a significant transition period before required implementation by governmental 401(k) plans.

Highlights of the Proposed LTPT Rules

The proposed regulations explain in detail how LTPT Rules apply in various situations, using helpful examples. We provide below a short summary of some of the guidance provided.

• “Long-term, part-time employee” definition. As mentioned above, a LTPT Employee is an employee who is eligible to participate in a qualified cash or deferred arrangement (“CODA”) solely because they are at least 21 years old and have at least 500 hours of service in applicable (i.e. 3 or 2) consecutive years. With respect to plan years starting on or after January 1, 2024, the applicable consecutive number of years is three. With respect to plan years starting on or after January 1, 2025, the applicable consecutive number of years is two. If an employee is eligible to participate in a CODA other than by satisfying the two requirements above (e.g., by working at least 1,000 hours in a year), the employee would be eligible to participate in a CODA, but not because the employee is a LTPT Employee. The LTPT Rules only apply to LTPT Employees. LTPT Employees do not include employees covered by a collectively bargained agreement and nonresident aliens.
• Eligibility conditions other than age or service are allowed. The IRS permits a 401(k) plan to continue to place certain restrictions on eligibility as long as they are not directly or indirectly related to age or service requirements under the LTPT Rules. For example, an employer may require a part-time employee to be hired by its specific division to be eligible to participate in a plan.
• Determining hours for eligibility.
  • Elapsed time method. A plan may use the elapsed time method, but in that case the individual would become an employee after one year of service, not on account of the LTPT Employee rules, and thus would be a regular participant, not an LTPT.
  • Equivalency method. To the extent the equivalency method of crediting service is set forth in its plan document, this method is permitted because the equivalency method provides a fixed number of service hours provided in a given month, regardless of whether an employee is full-time or part-time.
• Determination of 12-month periods. Any service provided prior to January 1, 2021 is disregarded for purposes of determining the applicable consecutive periods of service. For calculating periods on or after January, 2021, the initial 12-month period will begin the first day an employee is entitled to be credited with an hour or service, which is generally the first day of work for new employees. In cases where a plan document permits the use of the plan year for measuring an employee’s service credit, the IRS permits the initial 12-month period to be the employment start date and the subsequent 12-month period(s) to be based on the plan year.
• Entry Dates. Once an employee becomes eligible to participate under LTPT Rules, participation in a qualified CODA cannot begin later than the earlier of: (a) the first day of the plan year beginning after the date the employee becomes eligible under the LTPT Rules or (b) 6 months after satisfying the eligibility requirements under the LTPT Rules.
• Vesting. For purposes of determining an employee’s vesting rights, any service a LTPT Employee provided before January 1, 2021 is disregarded. Otherwise, a plan may use the calendar year, plan year or any other 12-consecutive month period to determine vesting rights of a LTPT Employee.
• “Former long-term, part-time employee” definition. A LTPT Employee becomes a former LTPT Employee if the employee completes at least 1,000 hours of service in a 12-month period or otherwise becomes ineligible due to reasons other than age or service conditions. With respect to former LTPT Employees who complete at least 1,000 hours of service in a 12-month period, such employees will be counted towards nondiscrimination and coverage testing provisions and the top heavy provisions beginning after the plan year in which such former LTPT Employee satisfy at least 1,000 hours of service in a 12-month period. However, the vesting rules for LTPT Employees will continue to apply, which may produce faster vesting than otherwise would be the case.
• No requirement to provide matching or non-elective contributions for LTPT Employees. The proposed regulations do not require that plan sponsors make matching contributions or non-elective contributions for LTPT Employees. However, LTPT Employees who become former LTPT Employees (see above), and who are otherwise eligible to participate in the plan, are not covered by this exclusion.
• LTPT Employees may be excluded from nondiscrimination and coverage testing, but not top-heavy testing. As long as a plan document explicitly excludes LTPT Employees from all nondiscrimination and coverage tests, the proposed regulations permit such an exclusion. A plan sponsor cannot pick and choose from which tests to exclude LTPT Employees.
• LTPT Employees may be excluded from top-heavy benefits and vesting requirements. A plan may exclude LTPT Employees from top heavy benefits and vesting.
• Eligibility for Catch-up and Roth contributions not required. The IRS explained that an employee who is eligible to make elective deferrals and is age 50 or older before the end of the employee’s taxable year may be permitted to make catch-up contributions. Similarly, Roth contributions are also permitted for LTPT Employees.