By: Ilene H. Ferenczy, Esq., CPC, APA
At the risk of sounding ungrateful, our Thanksgiving holiday was interrupted on Friday when the IRS finally issued the proposed regulations outlining how plans are supposed to comply with the Long-Term Part-Time Employee (“LTPT”) rules as of January 1, 2024. While our notes may be covered with gravy and cranberry sauce stains, we were pleased to help translate these new rules for you as soon as we could.
The new proposed rules are found in Treas. Reg. Section 1.401(k)-5, which was previously reserved for guidance related to mergers and acquisitions. (We’re not sure if this means that the IRS has thrown up its collective hands and decided not to provide M&A guidance …. Ever. Presumably (or hopefully, as the case may be), they will simply find a new location for such guidance should it ever be issued.) The preamble provides that we may rely on the proposed regulations in advance of them being finalized. In other words, these are the rules we will live with until further notice.
What You’ve Been Waiting For: Class Exclusions Can Apply to LTPTs … Usually
Let us clarify right up front that the IRS permits class exclusions to apply for LTPT purposes. Therefore, a plan that validly excludes certain groups of employees, such as people in given job positions or geographic locations, does not need to cover the LTPT employees in such groups. However, this exclusion right does not apply if the exclusion is a proxy for an age or service requirement.
What does this mean? First of all, you cannot exclude part-time or seasonal employees from LTPT status (and the right to defer) if they are credited with the requisite 500 hours in three consecutive years (two years beginning in 2025). Second, you cannot disguise an hours or age exclusion under another heading and have it be valid. For example, if you exclude all clerks and all clerks are part-time employees, it is likely that the IRS would find that exclusion to be a proxy for a service exclusion and require you to provide LTPT participation rights to those employees. Similarly, you cannot put all your part-timers in one company and all your full-time employees in another and then have only the company with full-time employees sponsor a plan.
On the other hand, exclusion of all nurses from a plan, when there are both full-time and part-time nurses on staff, is not a proxy for a service exclusion, and that exclusion could apply for LTPT purposes. Similarly, in situations where employment at a company is not a proxy for a service condition, if the plan of one company excludes employees at a related employer, that exclusion will apply to the LTPTs at the nonparticipating employer
The Second Most-Asked Question: Excluding LTPTs and TH Exemption for Safe Harbor Match
If you have a safe harbor plan and the LTPTs are excluded from all employer contributions, the failure to give employer contributions to the LTPTs will not cause the plan to lose its top-heavy exemption.
For example, a plan that is excused from ADP testing because it provides a safe harbor matching contribution of 100% of deferrals up to 4% of compensation is not considered to be a top-heavy plan if all employees who are eligible to make deferrals are similarly eligible to receive the matching contribution (and if no other employer contributions are provided). As of January 1, 2024, LTPTs must be permitted to make deferrals to the plan but are not required to receive the safe harbor match. Nonetheless, the plan will not be considered to be top-heavy.
Testing, Testing ….
How do you test ADP, ACP, other nondiscrimination rules, and coverage?
The regulations permit an employer to elect whether to include the LTPTs in testing or to provide them with safe harbor contributions. However, they require that this decision be made in relation to all nondiscrimination and coverage rules. The result is that, if you exclude LTPTs from nondiscrimination, they must be excluded from all nondiscrimination testing, even if you provide them with additional benefits.
For example, suppose that Law Firm A sponsors a 401(k) plan that excludes associate attorneys and is ADP tested. Law Firm A elects to exclude the LTPT employees from the nondiscrimination rules. This means that the LTPT employees are carved out of the coverage, ADP, and ACP testing entirely. Therefore, whether the exclusion of associate attorneys will be permitted under Code Section 410(b) will be determined without considering the LTPTs, either in the numerator or the denominator of the coverage fractions. Similarly, the ADP and ACP testing will not consider the LTPT employees at all – so that their rates of contribution, whether large or small, will have no effect on whether the plan has to make deferral refunds or match distributions.
On the other hand, suppose that Law Firm A (whose plan excludes associate attorneys) has only one LTPT – an associate attorney who defers at a rate of 10% of his pay. Law Firm A determines that it will pass coverage whether this LTPT associate is included in the testing or not, and also acknowledges that he will help pass the ADP test. The Law Firm may elect to include the LTPT in all testing.
While the plan document may permit the plan sponsor to elect (presumably each plan year) whether to include or exclude the LTPTs from testing, a safe harbor plan must specify in the document whether the safe harbor provisions will apply to the LTPTs. Such election must meet the safe harbor “full year” rules – in other words, it cannot be changed mid-year, in the same way that the applicability of the safe harbor rules generally may not be modified during the year.
Even if the LTPTs are excluded from nondiscrimination and coverage rules, the plan may provide (and the plan sponsor may elect, in the case of a discretionary amount) to contribute on behalf of the LTPTs. The regulations provide an example under which the normally-eligible employees receive a safe harbor nonelective contribution of 3% of pay, while the LTPTs are given a nonelective contribution of 2% of pay. The contribution for the LTPTs is not taken into account for any nondiscrimination testing.
The IRS seems to presume in the regulations that all LTPTs are, by definition, nonhighly compensated employees (NHCEs). However, this ignores the situation where a business owner is working in the business fewer than 1,000 hours during a year or where a child of the owners works part-time. There is no provision in the regulations to test nondiscrimination among the LTPTs, nor does the regulation require that contributions to LTPTs must go either to all or none of these employees. Therefore, one must question whether this is a potential area for creativity in the odd situation where an HCE is also an LTPT.
Top-Heavy Rules, On the Other Hand …
Top-heavy rules are another area where the employer may make an election to exclude the LTPTs. In particular, the employer may decide whether to give the LTPTs the top-heavy minimum contributions. That election must apply uniformly to all LTPTs. This election is completely separate from (and in no way dependent on) the nondiscrimination testing election.
However, unlike with nondiscrimination testing election, the accounts of LTPTs are always included in the determination of whether the plan is top-heavy. The exclusion of the LTPTs from receiving top-heavy benefits does not change this analysis.
As noted earlier, exclusion of the LTPTs from safe harbor contributions does not cause the safe harbor plan to lose its top-heavy exemption.
The More Mundane Stuff
The regulations, of course, address several practical issues that are used in administering a plan in 2024.
To Be an LTPT or Not to Be an LTPT
To be an LTPT, the only reason why the participant is eligible must be the application of the LTPT rules. If the employee becomes eligible for any other reason, they are not an LTPT.
The regulations provide many examples to show the applicability of this rule. If the plan has eligibility requirements that are more lenient than those of the LTPT rules (e.g., where hours are not an issue or where the otherwise LTPT will enter faster than required under the law), the employees are never LTPTs. For example, plans with immediate eligibility or that require a year of employment with 500 hours will never produce LTPTs, as employees will always enter faster than they would have under the LTPT rules.
Once a participant has entered the plan outside of the LTPT rules, whether or not they are an LTPT is never redetermined. So, for example, an employee who works more than 1,000 hours in their first employment year, and meets the plan’s one-year waiting period, will not be transformed into an LTPT if, in later years, they work between 500 and 999 hours in two consecutive years.
There are two times in which there is a change in LTPT status:
- When the LTPT employee has already entered the plan and in a later year works more than 1,000 hours. That individual becomes a Former LTPT (or “FLTPT”) as of the first day of the plan year after the year in which the employee has more than 1,000 hours of service. Such an individual will never become an LTPT again. Once the participant completes 1,000 hours in a plan year, all of the normal LTPT rules cease to apply to them, except the vesting rules. Therefore, the individual must be included in all nondiscrimination and coverage testing and also must receive applicable top-heavy minimum benefits. However, the FLTPT is entitled to years of vesting for years in which they work at least 500 hours.
- When an LTPT employee who is included in the plan becomes ineligible because they enter an ineligible class. If an LTPT employee enters an ineligible class (e.g., becomes a union employee or starts working in an excluded job category), they become an FLTPT. They no longer qualify for contributions under the plan (and can no longer make deferrals for the period after the change to the ineligible class), but will continue to earn vesting credit for years in which they work at least 500 hours. However, unlike the first category of FLTPT, an employee who becomes an FLTPT because they joined an ineligible class will again become an LTPT if they ever rejoin the eligible class. This reclassification applies for the year in which the status change occurs. Such an individual is either an LTPT or an FLTPT in a given year, never both.
Eligibility Computation Periods and Plan Entry
The rules for eligibility of LTPTs parallel normal eligibility rules in their application. The first period during which hours of service are to be judged for eligibility purposes – i.e., the eligibility computation period or “ECP” – is the year that begins with the employee’s date of hire. The plan will specify whether the second ECP is the second employment year or the plan year that begins during the first ECP. If the latter, the first employment year and the plan year beginning during that year are treated as “consecutive years” for purposes of the two- or three-year eligibility requirement. ECPs beginning before January 1, 2021, do not count in determining LTPT status.
Once the eligibility requirements are met, the LTPT must be permitted to begin deferrals by an entry date that meets the normal entry date requirements – i.e., they must be able to start deferring by the earlier of the first day of the plan year or the date six months after the employee fulfills the LTPT eligibility requirement. If the employee leaves the company after completing their eligibility requirements but before entering the plan, the employee must be permitted to enter the plan immediately upon rehire.
The plan may use equivalency rules for determining the hours requirement. The plan cannot use elapsed time for the two- or three-year eligibility requirement, because the employee is deemed to have a year of service after one year of elapsed time, would enter the plan under the normal eligibility rules, and would not be an LTPT.
Young employees present a special challenge. The LTPT rules require that the employee turn age 21 before entering and must do so before the end of the last year of the eligibility requirements. This becomes a problem if the employee fails to complete 500 hours in the year in which they turn age 21.
Example: Gene works for Burgers R Us, starting on January 1, 2023, when he is 19. He completes 600 hours in 2023, and 600 hours in 2024. He would normally enter the plan as of January 1, 2025, but he is not yet 21. He turns age 21 in 2025 but completes only 400 hours in that year. Because he has not completed at least 500 hours in the year in which he turns age 21, he does not enter the plan. He must wait until he has two consecutive years in which he is credited with at least 500 hours, so that he is at least age 21 in the second of those years. As 2025 is not one of those years (remember, he worked only 400 hours in that year), the earliest he would enter is January 1, 2028, after completing at least 500 hours in 2026 and 2027.
Okay, You Can Defer, But Not Fully
LTPTs cannot be limited in their deferrals in any way that would not be permitted for normal participants. Treas. Reg. Section 1.401(k)-3(c)(6) permits the following restrictions:
- Participants may be limited as to the frequency and duration of election periods, but must have a reasonable opportunity (at least 30 days) each year in which they can make or change deferral elections.
- NHCEs must be permitted to defer at least the amount needed to get the maximum matching contribution (even if they don’t qualify for the match!) or any lesser amount.
- Deferral elections can be limited to compensation types that would constitute “reasonable compensation” under the Section 414(s) definitions. For example, the plan could provide that employees cannot defer from bonus, even if that definition does not satisfy the compensation ratio test.
- Deferrals may be limited to prevent exceeding legal maximums under Code section 402(g) or 415, or under USERRA rules.
403(b) Plan Differences
The proposed regulations do not discuss 403(b) plans. Presumably, the 403(b) rules will be similar to the 401(k) rules except where the statute provides otherwise. The following are important differences:
- Only ERISA-covered 403(b) plans are subject to the LTPT rules. Governmental and nonelective church plans are exempt, as are deferral-only plans with limited employer involvement.
- The rules apply to 403(b) plans for plan years beginning after December 31, 2024.
- The rules disregard ECPs beginning before January 1, 2023.
- 403(b) plans are subject to the universal availability requirement, which generally provides that, if any employee can defer, all employees working for that employer must be allowed to defer. Code section 403(b)(12)(A) allows the plan to exclude employees working fewer than 20 hours per week and student employees. However, SECURE 2.0 amended that exclusion to provide that it does not apply to LTPT employees.
SIMPLE 401(k) Plans
Unlike regular 401(k) plans, SIMPLE 401(k) plan must provide the SIMPLE employer contribution to LTPTs.
The LTPT rules do not apply to SIMPLE IRAs.
Want to Know More?
If you want to know more, join us for an ERISApedia webcast on December 11 (repeated on December 13) at 2 p.m. Details can be found at ERISApedia.com.
And, of course, you can always call or email. After all, we are your ERISA solution!
- Posted by Ferenczy Benefits Law Center
- On November 27, 2023