SECURE 2.0 reduced the waiting period for LTPT employees to two consecutive years, but that change won’t apply until 2025. That is, LTPT employees who worked at least 500 hours in 2023 and 2024 must be allowed to defer beginning in 2025. SECURE 2.0 also applies the LTPT requirements to private-sector, ERISA-governed 403(b) plans.

Where LTPT employees are included “solely” in compliance with the statutory requirements, the LTPT employees’ deferrals and account balances won’t need to be considered for discrimination, ADP and ACP testing. In other words, Congress protected plan qualification because it realized that LTPT employees would likely defer less than other participants or perhaps not at all. 

While those changes may seem straightforward, they aren’t.

IRS Proposed Regulation
On November 4, 2023, the IRS issued a proposed regulation on issues related to the inclusion of LTPT employees in 401(k) and ERISA 403(b) plans. The proposal is 22 pages of fine print covering technical aspects of coverage, top heavy, discrimination testing, and more. While the regulation is only a proposal, the IRS says that compliance with its provisions will protect the qualified status of a plan even if the final regulation makes changes. 

Fortunately, if a plan sponsor adopts a straight-forward approach, the guidance doesn’t impose significant additional burdens. A straight-forward approach would be tracking hours to determine eligibility, allowing deferrals as required, and perhaps making employer and/or matching contributions under the plan’s regular formulas.

The greatest risk facing plan sponsors is that they aren’t aware of this new requirement.

However, if a plan sponsor varies from that approach, it can become complicated.

Here are some of the key points in the proposed regulation:

• Eligibility: If a plan varies from the statutory provisions, and eligibility is determined in a different way, the LTPT employees will be treated as “regular” participants, subject to the Code’s testing requirements and top-heavy contribution rules. For example, if a plan provides for immediate eligibility, the LTPT employees would be treated as regular participants. There is a similar result if the plan uses a 1-year wait (instead of the 3, and then 2, year waiting period in that statutes). The same is true if the plan doesn’t count hours, but instead uses an elapsed time or equivalency method of determining service for eligibility. 
• Employees excluded from participation: Fortunately, LTPT employees can, in some cases, be excluded from participation in the same way that full-time employees can be excluded. For example, a plan can exclude all employees, including LTPTs, who are younger than age 21. A plan can also exclude certain classes of employees, for example, all employees in a particular location or all associates at a law firm. However, that kind of class exclusion can’t be a device for excluding LTPT employees. In other words, a class can’t be created that is designed to exclude the LTPT employees from participation.
• Employees excluded from contributions: As mentioned earlier, the LTPT employees can be excluded from employer and matching contributions without any negative qualification consequences. But, what if the plan is a safe harbor plan with required contributions? The answer is the same. A plan sponsor isn’t required to provide safe harbor contributions for the LTPT participants.

An exception to this relief is for SIMPLE 401(k) plans. In that case, the regular employer contributions must be made for LTPT participants.

• Top-heavy testing: While plan sponsors aren’t required to make top-heavy contributions for LTPT participants, those participants must be included in top-heavy calculations. However, that shouldn’t result in problems since the LTPT account balances should increase the amounts for non-key participants in the top-heavy calculations. In addition, the exclusion of  LTPT participants from receiving top-heavy allocations won’t cause a safe harbor plan to lose its exemption from the top-heavy rules.
• Vesting: The vesting provisions in the proposed regulation are controversial. In effect, the proposal says that if an employee starts participation as a LTPT, then the employee will always be treated as a LTPT for vesting purposes. The significance is that a LTPT participant is entitled to a year of vesting credit for each plan year in which the LTPT employee works at least 500 hours (while regular participants would likely on get a year of vesting credit if they work at least 1,000 hours). While that requirement may not be relevant for LTPT employees where the sponsor doesn’t make contributions on their behalf, it will matter if a plan sponsor does make contributions on behalf of the LTPT participants. It could also matter if an employee later becomes a full-time employee and begins to receive contributions by a plan sponsor. Even in that case, the vesting would be calculated as if the participant were still an LTPT employee, that is, the 500 hour part-time years beginning in 2021 would each earn a year of vesting credit against the new employer contributions.
• Plan amendments: In the preamble to the proposed regulation, the IRS explains that 401(k) and ERISA 403(b) plans will not need to be amended for the SECURE 1.0 and 2.0 changes until the 2025 plan year—even if discretionary changes are made as a part of complying with the new mandates. (A discretionary change is a design feature that is in addition to the statutory requirements). While the amendments don’t need to be made until 2025, plans must comply operationally in 2024 for the SECURE 1.0 three-year requirement for 401(k) plans and in 2025 for the SECURE 2.0 two-year requirement for 401(k) and ERISA 403(b) plans.

Concluding Thoughts

The greatest risk facing plan sponsors is that they aren’t aware of this new requirement and accidentally fail to include LTPT employees in their 401(k) plans in 2024. Financial professionals should be alerting their plan sponsor clients to this requirement.

In addition, financial professionals should talk to plan sponsors about the role that LTPT employees play at the company and whether it makes sense to contribute for those employees.

Finally, financial professionals and service providers should be talking to plan sponsors about the design issues for plans and their consequences.