The SECURE Act was passed in late 2019, in what seems like another era, with the goal of increasing participation in 401(k) plans. One way to reach that goal was a new mandate, starting in 2021, to track long-term, part-time employees and require that they be given the opportunity to make salary deferrals. (This provision was mentioned in our first review of the legislation when it passed the House.)
Now in the midst of an ongoing pandemic, employers need to manage the implementation of that mandate, but there are some options that may be simpler to use and even more favorable for participation by part-time employees.
SECURE Act 401(k) Rules for Part-Time Employees
The SECURE Act requires that part-time employees be allowed to participate in salary deferrals under their employer's 401(k) plan1 if they complete three consecutive 12-month periods, each with at least 500 hours of service. Although not required, an employer could choose to let part-time employees share in employer contributions too.
Since plans can require no more than 1,000 hours in a 12-month period to participate, part-timers working 500-999 hours are the target group. (The plan may also impose an age requirement up to age 21 by the end of the three-year period.)
For eligibility purposes, 12-month periods beginning before January 1, 2021, are not taken into account, so targeted part-time employees need not actually be enrolled until January 1, 2024, at the earliest. However, employers implementing this provision must track hours worked starting in 2021, and also retain those records over a period of years, rather than determining eligibility one year at a time.
As noted above, to limit the burden on employers, the new mandate for long-term, part-time employees applies only to elective deferrals. Anyone who works less than 1,000 hours in a year can still be excluded from matching and other employer contributions. In addition, part-time employees who become eligible solely under the new rule do not count for nondiscrimination (ADP testing) purposes.
On the other hand, recent IRS guidance says that for employees who enter the plan under this rule, all years with at least 500 hours will count for vesting purposes—including years prior to 2021. That may not matter if the part-time employee is only eligible for salary deferrals (which by law are always 100 percent vested), but tracking the earlier service could be burdensome for an employer if the part-time employee becomes eligible for employer contributions.
Employer Alternatives to Comply With SECURE Act 401(k) Rules
Employers do have some alternatives to implementing this new rule. Many 401(k) plans already allow immediate eligibility or have a very short waiting period for salary deferrals, with no hours requirement, while requiring 1,000 hours for employer contributions. That design eliminates the need to track hours for eligibility and allows participation sooner than required under the SECURE Act.
Some employers may want to move to that design instead of implementing the new mandate. The downside to this alternative is that the exclusion from discrimination testing will not apply—so adding large numbers of part-time employees who do not actually contribute could significantly hurt ADP testing for the highly compensated. (Of course ADP testing can be eliminated with a safe harbor match, but that may be more expensive for the employer.)
Another alternative is to use hours equivalencies instead of tracking exact hours. Department of Labor rules allow a plan to credit 45 hours per week or 190 hours per month if the employee works one hour in the week or month. This will always get the employee over the 500 hour threshold faster than counting exact hours. But it may also allow them to attain the 1,000 hour eligibility requirement for employer contributions.
Either of these alternatives also has to deal with the possibly retroactive effect on vesting under the IRS guidance. Some plans already use the "elapsed time" method for vesting, where hours are not counted, so that could be implemented, although it is much more liberal in allowing part-time and intermittent employees to vest. Hours equivalencies can also be used for vesting purposes to simplify having to record hours while still retaining a 1,000 hours per year requirement.
Employers should therefore start to consider alternatives to the new mandate and the effect they may have on plan participation, or prepare to start tracking hours for part-time employees.
1 This mandate does not apply to 403(b) plans and 457(b) plans, which have their own eligibility rules.