By: S. Derrin Watson, Esq. and Alison J. Cohen, Esq.
Many of you have been wondering why Ferenczy Benefits Law Center has been strangely silent for the past two months regarding SECURE 2.0. The answer is that our nerd herd has been busy digesting the new legislation and determining what we believe the guidance might look like and where the pain points are likely to land for the folks in our industry. Start looking forward to future Flash newsletters where we get down and nerdy, picking things apart. Of course, as guidance is released (including, the elusive guidance from SECURE 1.0), we will be providing thoughtful updates.
Reader’s Digest Version of Long-Term, Part-Time Rules
By now, most, if not all, of you have read and heard about the Long-Term, Part-Time (“LTPT”) rules that were created in 2019 with SECURE 1.0. The Congressional concern being addressed was that more Americans are working in a part-time capacity, defined as working fewer than 1,000 hours, but more than 500 hours. Because these LTPT employees don’t reach 1,000 hours, they can be excluded from a 401(k) plan that requires 1 year of service with at least 1,000 hours to be eligible. Thus, they will never be able to make deferrals and create retirement savings for themselves.
In SECURE 1.0, Congress made it so that LTPTs who complete 3 consecutive years of service, during which they work between 500 and 1,000 hours, will be permitted to enter a retirement plan solely for deferral purposes. SECURE 2.0 reduced this eligibility period to only 2 consecutive years of service, starting in 2025. (The 3-year rule continues to apply only for 2024, and only for 401(k) plans.) SECURE 2.0 also included language to subject ERISA 403(b) Plans to the LTPT fun, starting in 2025. Questions have arisen as to whether the LTPT rules will override a class exclusion in a 403(b) for employees working fewer than 20 hours and/or student employees. Some practitioners have opined that the LTPT requirements will not override the exclusion rules. Although no one has issued formal guidance, here is why we believe that, unfortunately, both exclusions will be overridden by the new LTPT requirements in 2025.
Start at the Beginning, Which is a Very Good Place to Start
Below is the excerpt from Internal Revenue Code (the “Code”) Section 403(b)(12)(A) regarding Universal Availability, as written before SECURE 2.0 kicks in:
For purposes of paragraph (1)(D), a plan meets the nondiscrimination requirements of this paragraph if …
(ii) all employees of the organization may elect to have the employer make contributions of more than $200 pursuant to a salary reduction agreement if any employee of the organization may elect to have the organization make contributions for such contracts pursuant to such agreement.
… For purposes of clause (ii)…
Subject to the conditions applicable under section 410(b)(4), there may be excluded for purposes of this subparagraph employees who are students performing services described in section 3121(b)(10) and employees who normally work less than 20 hours per week.
The student employee and 20 hours-per-week exemptions are contained in the last sentence quoted above.
Here is that last sentence, as changed by SECURE 2.0, effective for plan years beginning after 2024:
Subject to the conditions applicable under section 410(b)(4) and section 202(c) of the Employee Retirement Income Security Act of 1974, there may be excluded for purposes of this subparagraph employees who are students performing services described in section 3121(b)(10) and employees who normally work less than 20 hours per week. [Emphasis added to reflect change by SECURE 2.0]
ERISA section 202(c) is the new ERISA LTPT rule. How can one read the italicized inserted language other than as saying the LTPT rule is an exception to both the 20-hour and student-employee exemption? After all, it has been made a condition for both types of exclusions that had previously existed, and which still exist outside the LTPT context.
There’s an interesting side note relating to these two exemptions as applied to LTPT employees. The 20-hours exemption applies at hire only if the employer reasonably concludes that the employee will work fewer than 1,000 hours in the first year. Thereafter, the question is whether the employee ever was credited with 1,000 hours in an “exclusion period” (essentially an eligibility computation period). [Treas. Reg. §1.403(b)-5(b)(4)(iii)(B)]
But the student-employee exemption, on the other hand, has no relationship to 1,000 hours. In theory, a student could work 1,200 hours in a year (perhaps shifting to full-time status during the summer) and still be excluded from the plan under the student-employee exemption. But if, after 2022, they have two consecutive years with at least 500 hours of service, they will enter the plan as an LTPT, even if they will not receive any employer contributions because of the student-employee exemption.
Fortunately, we have 2 more years before this rule is effective for 403(b) plans, allowing us to wait for the IRS to publish a clarification.
Remember that the LTPT rule for 403(b) plans is limited to plans subject to ERISA. Therefore, it does not apply to governmental plans, church plans, or to certain deferral-only plans. But that leads us to our next wrinkle.
Something Else to Keep You Up at Night
Because you can’t hold a good ERISA nerd down, we found an additional quirk that will need to be resolved, in our humble opinion, by the good people in Washington DC.
Beginning in 2025, many 403(b) plans will be subject to the new mandatory automatic enrollment provisions. [Code §414A(a)(2), as added by SECURE 2.0, §101] This requirement is not limited to 403(b) plans otherwise subject to ERISA.
Years ago, the Department of Labor (“DOL”) issued what it refers to as a “safe harbor regulation” to provide that a class of deferral-only 403(b) plans is exempt from ERISA. [DOL Reg. §2510.3-2(f)] One of the conditions of that Regulation is that participation must be “completely voluntary” for employees. The DOL addressed the definition of “completely voluntary” in connection with a different ERISA exemption, this one for employer-sponsored payroll withholding IRA savings arrangements. [DOL Reg. §2510.3-2(d)] This exemption uses the same terminology as the 403(b) exemption and is found in another section of the same Regulation. The DOL commented:
With regard to the 1975 IRA Payroll Deduction Safe Harbor’s condition requiring that an employee’s participation be ‘‘completely voluntary,’’ the Department intended this term to mean that the employee’s enrollment in the program must be self- initiated. In other words, under the safe harbor, the decision to enroll in the program must be made by the employee, not the employer. If the employer automatically enrolls employees in a benefit program, the employees’ participation would not be ‘‘completely voluntary’’ and the employer’s actions would constitute the ‘‘establishment’’ of a pension plan, within the meaning of ERISA section 3(2).
Unless the DOL revises its views on “completely voluntary,” it appears that 403(b) plans subject to automatic enrollment in 2025 will not be able to qualify for the safe harbor ERISA exemption for deferral-only plans. And this would have incredibly far-reaching implications in relation to how current non-ERISA plans operate.
Have no fear, Ferenczy friends, we will continue to provide support to you and your practice as we navigate these murky waters and digest forthcoming guidance. Because, as always, we are your ERISA Solution.
(And, by the way, for more information on plans for tax-exempt employers, check out Derrin’s terrific books on 403(b) and 457 plans available exclusively on ERISApedia.)
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- Posted by Ferenczy Benefits Law Center
- On March 7, 2023