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02/18/2021

401(k) Plans: New Eligibility Rules For Long-Term, Part-Time Employees

The Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”) made several changes to the retirement plan rules with varying effective dates. One change, that is effective for plan years beginning after December 31, 2020, is the requirement that long-term, part-time employees who work 500 hours or more per year for three consecutive years be eligible to participate in a company-sponsored 401(k) Plan. This means plan sponsors must, beginning with the 2021 plan year, keep track of hours for part time employees to determine whether the employee works 500 or more hours. If an employee works 500 or more hours in the plan year beginning in 2021, and each year for the next two plan years, the employee must be eligible to make elective deferrals beginning with the plan year beginning in 2024. Plan sponsors and service providers should ensure that procedures are in place to comply with the new rules. Alternatively, plan sponsors may wish to expand their plans’ eligibility provisions in a manner that avoids having to track different classes of employees and their hours for plan eligibility purposes. If a plan does not have an “hours of service” requirement with respect to eligibility, or if the hours requirement is less than 500 within a 12-month period, the plan will already be in compliance with the new law.

The existing eligibility requirement for 401(k) Plans provides that upon working 1,000 hours in a 12-month period, an eligible employee must be permitted to participate in the plan. Such participation must begin no later than within the six-month period following satisfaction of the eligibility requirements. In addition, the plan can impose an age 21 requirement in order for the eligible employee to become a plan participant. The 1,000 hour one-year requirement is retained under the SECURE Act and the permissible age 21 requirement is unaffected.

Under the SECURE Act, in addition to the 1,000 hour one-year requirement, an eligible employee who works 500 or more hours in a 12-month period, and does so for three consecutive years, must also be permitted to participate in the 401(k) elective deferral feature of the plan. The 12-month period is measured beginning with the date the employee commences employment and each subsequent 12-month period. However, the plan may provide that subsequent computation periods be based on the plan year beginning with the plan year in which the employee completes his or her initial 12-month computation period. The long-term, part-time eligibility rule retains the requirement that the participant commence participation on the earlier of the first day of the plan year beginning after satisfaction of the eligibility requirements or 6 months after satisfaction of the 3-year 500-hour per year requirement. The plan may, and many plans do, provide for an earlier entry date such as the first day of the month following satisfaction of the eligibility requirements.

The requirement to allow long-term, part-time employees with three consecutive years of 500 or more hours of service only pertains to the employee's eligibilty to make elective deferrals from his or her compensation pursuant to the 401(k) cash or deferral arrangement. Plan sponsors are not required to make matching or employee non-elective (profit sharing) contributions on behalf of such employees. Although not required to do so, a plan certainly may match the long-term, part-time employees’ elective deferrals and include such employees as eligible for non-elective contributions. The non-discrimination and top-heavy rules do not apply to the long-term, part-time employees. In addition, the long-term, part-time rules do not apply to employees covered by a collective bargaining agreement if retirement benefits were the subject of good faith bargaining.

For long-term, part-time employees who are eligible for employer contributions under the terms of the plan, or who become eligible for such contributions, a special vesting rules applies. Vesting rules historically may require that an employee work 1,000 hours or more in the vesting computation period in order to receive a year of vesting service. With regard to long-term, part-time employees, a year of vesting credit is earned for each 12-month period for which the employee is credited with 500 or more hours of service. This 500-hour vesting year will apply to matching and non-elective amounts subject to a vesting schedule with respect to long-term, part-time employees. The vesting credit rules for long-term, part-time employees apply for years beginning prior to 2021 unless an exclusion applies. If a long-term, part-time employee satisfies the existing eligibility requirements of 1,000 hours and one-year of service, the special rules of the SECURE Act for long-term, part-time employees will no longer apply to the employee.

Although amendments reflecting the provisions of the SECURE Act are not required to be in place until the last day of the plan year beginning on or after January 1, 2022, sponsors of plans with service requirements need to be mindful of the need to track hours worked by part-time employees. In addition, hours worked prior to 2021 must be reviewed for vesting credit purposes. Employers should review their payroll systems in order to ensure compliance with the new rules.