3757 / What participation and coverage requirements apply to 401(k) plans?

Editor’s Note: The SECURE Act has changed the law on mandatory eligibility to include long-term part-time employees. Under prior law, employers were permitted to exclude employees who performed fewer than 1,000 hours of service per year from participation in the employer-sponsored 401(k). The SECURE Act modified this rule in order to expand access for certain part-time employees. Under the new law, nonunion employees who perform at least 500 hours of service for at least three consecutive years (and are at least 21 years old) must be allowed to participate in the employer-sponsored 401(k). The SECURE Act 2.0 reduces the three-year period to two years for tax years beginning after 2024. These long-term, part-time employees may be excluded from coverage and nondiscrimination testing requirements. This SECURE Act provision became effective for plan years beginning after December 31, 2020. However, 12-month periods beginning before January 1, 2021 were not taken into account for purposes of determining whether an employee qualifies.¹ Therefore, an employer was only required to track part time employees on a going forward basis. However, the same is not true for tracking the vesting of employer contributions, based upon Notice 2020-68.

Planning Point: Post-SECURE Act, employers are still permitted to impose certain job-based restrictions on eligibility as long as those restrictions are reasonable and non-discriminatory (i.e., exclusions based on job function or location).  Because the new changes have increased scrutiny on the classifications used by employers, employers should be extra cautious to ensure that any classifications are not a backdoor way to circumvent the service requirements.

Section 401(k)(15)(B)(iii) provides special vesting rules for an employee who becomes eligible to participate in a CODA solely by reason of having completed three consecutive 12-month periods during each of which the employee completed at least 500 hours of service (long-term, part-time employee). A long-term, part-time employee must be credited with a year of service for purposes of determining whether the employee has a nonforfeitable right to employer contributions (other than elective deferrals) for each 12-month period during which the employee completes at least 500 hours of service.² In addition, Section 401(k)(15)(B)(iii) modifies the break-in-service rules of Section 411(a)(6) for a long-term, part-time employee. The special vesting rules of Section 401(k)(15)(B)(iii) continue to apply to a long-term, part-time employee even if the long-term, part-time employee subsequently completes a 12-month period during which the employee completes at least 1,000 hours of service.³

The IRS has clarified that the rule providing that 12-month periods beginning before January 1,
2021 are not taken into account does not apply for purposes of the vesting rules. Generally, all years of service with the employer maintaining the plan must be taken into account for purposes of determining a long-term, part-time employee’s nonforfeitable right to employer contributions under the special vesting rules. For purposes of determining whether a long-term, part-time employee has a nonforfeitable right to employer contributions (other than elective deferrals), each 12-month period for which the employee has at least 500 hours of service is treated as a year of service. All years of service with the employer maintaining the plan are taken into account for purposes of determining an employee’s nonforfeitable right to employer contributions, subject to certain exceptions. Those exceptions include, for example, years of service before the employee attains age 18.⁴

A plan may not require, as a condition of participation in the cash or deferred arrangement, that an employee complete a period of service beyond the later of age 21 or the completion of one year of service.⁵