401(k) Plan Sponsors – Time to Focus on Compliance with the SECURE Act’s Eligibility and Vesting Rules for Long-Term, Part-Time Employees

As noted in our January 7, 2020 Client Advisory, the Setting Every Community Up for Retirement Enhancement Act of 2019 (the “SECURE Act”) requires 401(k) plans to allow certain long-term, part-time employees to make elective deferrals. The SECURE Act also mandates special vesting rules for such employees with respect to other types of employer contributions to 401(k) plans (e.g., matching contributions and nonelective contributions). This post (1) summarizes these new requirements, and (2) offers some considerations for 401(k) plan sponsors to weigh as they turn their attention to compliance with these requirements, which are effective for plan years beginning after December 31, 2020.

New Eligibility Rule for Elective Deferrals

Under current law, employees who have not attained age 21 and completed a 12-month period during which they are credited with at least 1,000 hours of service may be excluded from participation in a 401(k) plan. Effective for plan years beginning after December 31, 2020, the SECURE Act requires that long-term, part-time employees who are non-union employees must be permitted to make elective deferrals under an employer’s 401(k) plan after three consecutive 12-month periods during each of which the employee has completed at least 500 hours of service; provided the employee has attained age 21 by the end of the three consecutive 12-month periods.

The following points bear emphasizing:

• 12-month periods beginning before January 1, 2021 are not taken into account for purposes of the new eligibility rule (but, as explained below, they generally are taken into account for purposes of the special vesting rules). Accordingly, the earliest date a long-term, part-time employee could become eligible to make elective deferrals under the new eligibility rule is January 1, 2024, provided the employee is at least age 21 by such date.
• Employees who become eligible solely under the new rule only have to be provided with the opportunity to make elective deferrals; they may continue to be excluded from eligibility for other types of employer contributions made to the 401(k) plan (e.g., matching contributions and nonelective contributions) until they meet the plan’s eligibility service requirement for such contributions.
• The new eligibility rule does not apply to union employees.
• An employer may elect to exclude employees who become eligible solely under the new rule for purposes of nondiscrimination and coverage testing, and in applying the top-heavy minimum benefit and vesting requirements. If and when such employee completes a 12-month period during which he or she is credited with at least 1,000 hours of service, then, as of the first plan year that begins after such date, he or she may no longer be excluded from nondiscrimination and coverage testing or in applying the top-heavy requirements.

Special Vesting Rules

Under current law, and as a general rule, employees who have completed a 12-month period during which they are credited with at least 1,000 hours of service must be credited with one year of vesting service. The SECURE Act adds special vesting rules for employees who become eligible to make elective deferrals solely by reason of the new eligibility rule. Specifically, such an employee must be credited with a year of service for vesting purposes for each 12-month period during which he or she completes at least 500 hours of service. In addition, the definition of “break in service” is modified for such employees by replacing “more than 500 hours of service” with “at least 500 hours of service” (i.e., the definition, as applied to such employees, is: a 12-month period during which the participant has not completed at least 500 hours of service). Lastly, these two special vesting rules continue to apply to a long-term, part-time employee even if such employee subsequently becomes a “full-time” employee (meaning, completion of a 12-month period during which he or she is credited with 1,000 or more hours of service).

In Notice 2020-68, the IRS confirmed that all years of service – even those beginning before January 1, 2021 – count under the special vesting rules, subject to certain exceptions (e.g., a plan may provide that years of service before an employee attains age 18 are excluded).

Example: Assume Employee X is age 21 and completes 550 hours of service during each 12-month period[1] from January 1, 2016 to December 31, 2023. Employee X becomes eligible to make elective deferrals under her employer’s 401(k) plan in 2024 because she has completed at least 500 hours of service in each of the three consecutive 12-month periods beginning on January 1, 2021. Later in 2024, Employee X becomes a full-time employee, and she then becomes eligible for matching contributions on January 1, 2025. Employee X’s years of service prior to 2021 must be taken into account for purposes of determining her vested interest in any matching contributions made on her behalf. Accordingly, as of January 1, 2025, Employee X would be credited with 9 years of vesting service (not 4 years).

In Notice 2020-68, the IRS acknowledged the potential administrative burdens related to counting years of service beginning before January 1, 2021 for purposes of determining a long-term, part-time employee’s vested interest in employer contributions (other than elective deferrals, which are always 100% vested) and specifically requested comments on how to reduce those burdens while still complying with the new rules. Comments are due November 2, 2020, and we expect further guidance from the IRS on this topic.

Considerations for 401(k) Plan Sponsors

Plan sponsors whose 401(k) plans currently require employees to complete a 12-month period during which they are credited with at least 1,000 hours of service in order to be eligible to make elective deferrals (or include some other eligibility requirement that is more restrictive than the new eligibility rule) should be reprogramming their plan administrative systems and procedures (including coordination with the plan recordkeeper’s systems) to successfully track service with respect to periods beginning on or after January 1, 2021 in order to comply with the new eligibility rule for elective deferrals (e.g., reprogramming for a new 500 hours of service indicator in a 12-month period; reprogramming to track for three consecutive 12-month periods). In addition, to comply with the special vesting rules, plan sponsors whose 401(k) plans include a vesting schedule for employer contributions need to begin assessing their ability to retrieve hours data to determine vesting service for periods beginning before January 1, 2021. If an employer does not have pre-2021 actual hours of service data for its employees who were not credited with at least 1,000 hours of service in a 12-month period, it may need to consider using an equivalency method for determining hours of service to be credited to an employee for periods beginning before January 1, 2021. IRS guidance addressing this issue would be helpful.

Plan sponsors that find compliance with the SECURE Act’s new eligibility and vesting rules overly burdensome may want to consider amending their 401(k) plans to provide for immediate eligibility solely with respect to elective deferrals. If all employees are immediately eligible for elective deferrals, then the SECURE Act’s special vesting rules will never come into play, and the 401(k) plan’s existing eligibility and vesting rules for other types of employer contributions can continue to apply to all employees.

Deadline for 401(k) Plan Amendments

While the SECURE Act’s eligibility and vesting rules for long-term, part-time employees are operationally effective for plan years beginning after December 31, 2020, the deadline for amending a 401(k) plan to reflect those rules is the last day of the first plan year beginning on or after January 1, 2022 (e.g., December 31, 2022 for plans with a calendar year plan year).

Please contact a member of our Employee Benefits & Executive Compensation Group if you have any questions regarding the SECURE Act’s eligibility and vesting rules for long-term, part-time employees that apply to 401(k) plans.