On November 24, 2023, the Internal Revenue Service (IRS) proposed long-awaited regulations providing guidance on the required coverage of long-term, part-time employees (LTPTEs) under the Setting Every Community Up for Retirement Enhancement Act (SECURE 1.0) and the SECURE 2.0 Act of 2022 (SECURE 2.0). This first piece of guidance to squarely address the LTPTE provisions arrived just weeks before the January 1, 2024 required LTPTE entry date under SECURE 1.0.
BACKGROUND
In general, SECURE 1.0 required 401(k) plans to extend participation to employees who complete 500 hours of service in each of three consecutive 12-month periods. Periods of service prior to January 1, 2021 are not taken into account for making this eligibility determination, which makes January 1, 2024 the earliest date that a 401(k) plan is required to extend participation to an LTPTE.
Piggybacking off SECURE 1.0, SECURE 2.0 extended the LTPTE rules to 403(b) plans covered by the Employee Retirement Income Security Act of 1974 (ERISA) and decreased the number of consecutive 12-month periods in which employees needed to complete 500 hours of service from three to two. Although the LTPTE rules require employers to extend 401(k) participation to LTPTEs for the purpose of making elective deferrals, employers are not required to provide matching or nonelective contributions on behalf of LTPTEs.
In addition, the LTPTE rules provide broad exclusions and relief from many testing and compliance requirements, such as minimum coverage and nondiscrimination testing, actual deferral percentage (ADP) and actual contribution percentage (ACP) testing, and vesting and benefit requirements under the top-heavy rules.
For more details regarding the SECURE 1.0 and SECURE 2.0 requirements, see our articles on SECURE 2.0, Notice 2020-68 (guidance under SECURE 1.0), and SECURE 1.0.
THE PROPOSED REGULATIONS
In many respects, the proposed regulations confirm the manner in which the majority of the LTPTE provisions under SECURE 1.0 and SECURE 2.0 were anticipated to be implemented and administered. However, the proposed regulations also include some new rules and helpful clarifications.
LTPTEs Only Include LTPTEs
The proposed regulations include numerous examples emphasizing that an employee is an LTPTE only if the employee is eligible to participate in the plan solely because the employee satisfies the LTPTE eligibility rules.
If an employee is eligible to participate in the plan because the plan's eligibility rules are more generous (e.g., the plan provides that all employees are immediately eligible to participate in the plan), the employee is not an LTPTE and none of the special LTPTE rules apply to that employee. This means, for example, that the special LTPTE vesting rules and testing relief would not apply to such an employee.
Clarification and Confirmation of Eligibility Service-Counting Rules for LTPTEs
Eligibility Exclusions by Class
As hoped, the proposed regulations confirm that a plan may retain bona fide class-based eligibility exclusions (e.g., an exclusion for employees working in a particular business unit or division) if the class exclusion is not a proxy for age or service. This means that any LTPTE employees who are part of the excluded class can continue to be excluded.
However, any such excluded employee cannot be treated as an LTPTE—regardless of whether such individual otherwise satisfies the definition of an LTPTE—for purposes of applying the LTPTE employee compliance and testing relief.
Use of Hours-Counting Equivalencies
The proposed regulations confirm that instead of counting actual hours worked toward the 500-hour test for LTPTE status, a plan may choose to apply any equivalency method permitted under applicable regulations. For example, the plan may credit an employee with 190 hours for any month in which the employee must be credited with at least one hour of service.
Given that these equivalences are based on full-time service, they are likely to be far more generous than actual hours. In response to practitioner and employer-side industry comments, the IRS specifically declined to prorate the equivalencies for LTPTEs.
Use of Elapsed Time Service Counting
The proposed regulations provide that the LTPTE rules do not apply to plans that utilize the elapsed time service-counting rules (i.e., plans that count service on the basis of an employee's period of service rather than hours worked). As a result, a plan that uses elapsed time for eligibility purposes may continue to do so and does not need to count hours or otherwise identify or track LTPTEs.
However, this also means that a plan using elapsed time service counting cannot treat any part-time employees as LTPTEs for purposes of taking advantage of the special nondiscrimination testing rules and relief that is available for LTPTEs (discussed below).
12-Month Measuring Period for LTPTE
The proposed regulations provide that the initial 12-month measuring period used for purposes of applying the LTPTE rules must begin on an employee’s date of hire. But, thereafter, a plan has the choice of continuing to count the 12-month measuring period on the anniversary of the employee's hire date or changing the 12-month period to the plan year, beginning on the first day of the plan year that occurs within the initial 12-month period.
For plans that change to the plan year measuring period, the initial and immediately subsequent plan year are treated as two consecutive 12-month periods for purposes of the LTPTE rules. While this rule of administrative convenience likely simplifies administration, it may result in LTPTEs becoming eligible to participate in a plan more quickly than plans that continue to count 12-month measuring periods based on the employee's anniversary date.
Entry Date
The proposed regulations confirm that the entry date concepts from the traditional service-counting rules apply. More specially, an LTPTE must become eligible to make a deferral election no later than the earlier of (1) the first day of the first plan year that begins after the date on which the LTPTE satisfies the applicable requirements, and (2) the date occurring six months after the date on which the LTPTE satisfied the applicable requirements.
Rehires and Break-in-Service Rules
In general, the LTPTE rules do not include break-in-service rules or concepts that are used under the regular service-counting rules. If an LTPTE has become eligible to participate in a plan and then terminates employment, the LTPTE employee must be eligible to resume participation immediately upon rehire, regardless of the duration of the break in service.
However, if an employee has not yet become eligible to participate in a plan as an LTPTE and they complete less than 500 hours of service during a 12-month measuring period, all the employee's prior service is disregarded for purposes of applying the LTPTE service-counting rules.
Rules for Determining Vesting Service for LTPTEs
In general, the LTPTE rules provide that a plan must credit an LTPTE with one year of vesting service for each 12-month period during which the employee is credited with at least 500 hours of service. The proposed regulations clarify that any 12-month period not otherwise prohibited under pre-SECURE 1.0 vesting rules may be used for this purpose.
This means that a plan would not be required to use the same measuring period that is used for purposes of counting an LTPTE's eligibility service (e.g., a plan could use its calendar-year plan year for counting an LTPTE's vesting service). Consistent with SECURE 2.0, the proposed regulations also confirm that 12-month periods beginning before January 1, 2021 are not required to be taken into account for purposes of determining a LTPTE's vesting service.
The vesting service rules will not be relevant for many LTPTE employees who never become eligible to receive employer matching or nonelective contributions that are subject to a vesting schedule (e.g., the LTPTE employee never works more than 1,000 hours of service in a measuring period or otherwise becomes eligible for employer contributions).
However, for an LTPTE who becomes eligible to receive employer contributions (a so-called "former LTPTE" under the proposed regulations), the plan must credit the former LTPTE with all of the LTPTE's past years of vesting service (including those under the LTPTE 500-hour year of vesting service rule), and the plan must continue to apply the LTPTE 500-hour year of vesting service-counting rules to the former LTPTE on a going-forward basis.
These former LTPTE vesting rules would seem to be quite complicated to administer and will also result in LTPTEs being subject to more favorable vesting rules than regular, full-time non-LTPTEs. However, practically speaking, these issues may exist only for plans that use a graded vesting schedule exceeding three years.
Former LTPTEs
Along similar lines, if a former LTPTE satisfies the plan’s more stringent age and service requirements for employer contributions, that employee, as of the first day of the plan year after the employee satisfies the plan’s more stringent age and service requirements, is no longer an LTPTE for purposes of the employer contribution exclusion or nondiscrimination testing. However, the former LTPTE must continue to earn years of vesting service based on the 500 hours/year rule that applies to LTPTEs.
Nondiscrimination Testing Rules and Relief
The proposed regulations confirm that an employer may elect to exclude LTPTEs from many of the Internal Revenue Code's (Code’s) otherwise applicable testing rules (including the nondiscrimination requirements of Code Section 401(a), the ADP/ACP actual deferral and contribution percentage tests, the ADP/ACP safe harbor provisions, and the Code Section 410(b) minimum coverage requirements).
The proposed regulations state that an employer's election must apply to all of the otherwise applicable tests and requirements, and an employer may not choose to selectively exclude LTPTEs from some tests but include them in others. The proposed regulations also make it clear that an employer can exclude LTPTEs from the ADP/ACP safe-harbor contributions and testing, but still choose to make other employer contributions to LTPTEs (e.g., different or lower levels of employer contributions to LTPTEs).
From a plan documentation standpoint, a plan that is not a safe-harbor plan for purposes of the ADP/ACP safe-harbor provisions must include enabling provisions that permit the employer to make the testing election and apply it administratively. By contrast, for a plan that is a safe-harbor plan, the plan document must specifically include the testing election to exclude an LTPTE employee from the otherwise applicable testing requirements.
Top-Heavy Testing Rules and Relief
Similar to the nondiscrimination testing rules and relief described above, an employer may also elect to exclude LTPTEs from receiving top-heavy benefits and from being subject to the accelerated top-heavy vesting rules. The proposed regulations make it clear that this employer election does not apply for purposes of determining whether a plan is top-heavy in the first instance.
However, the proposed regulations provide that for an employer with a safe-harbor plan making this top-heavy election, the plan will continue to be excluded from the top-heavy rules. The proposed regulations further note that the top-heavy election (1) is separate from the nondiscrimination testing election, (2) must apply to all LTPTEs, and (3) must be included in the plan document.
Amendment Rules and Relief
In general, the deadline for amending a 401(k) plan to comply with the SECURE 1.0 and SECURE 2.0 LTPTE provisions is the same as the deadline for other SECURE 1.0 and 2.0 requirements as extended under Notice 2024-02 (i.e., December 31, 2026 for a calendar-year nongovernmental plan and December 31, 2029 for a calendar-year governmental plan).
The proposed regulations are helpful in clarifying that this amendment deadline applies even if the particular changes made by an employer to comply with the LTPTE rules are more expansive than the minimum necessary requirements to comply with the LTPTE rules. For example, an amendment to make all employees immediately eligible to participate in a 401(k) plan would be subject to the extended amendment deadline.
CONCLUSION
The proposed regulations helpfully confirm and clarify many aspects of the LTPTE rules. However, some rules and interpretations (particularly, the vesting rules for former LPTEs) may create administrative issues and headaches. Until the proposed regulations are finalized, employers may rely on the proposed regulations.
As noted above, the IRS issued the proposed regulations mere weeks before the January 1, 2024 effective date for the SECURE 1.0 LTPTE rules. For some employers with large numbers of LTPTEs and/or other part-time workers, the LTPTE rules may prove challenging to administer.
Pending finalization of the proposed regulations, employers should work with their recordkeepers, providers, and legal counsel to comply with the LTPTE rules and requirements.
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