In the past, companies have been allowed to limit access to their 401(k) plan to just full-time employees but that is about to change starting in 2024. With the passing of the Secure Act, beginning in 2024, companies that sponsor 401(K) plans will be required to allow part-time employees to participate in their qualified retirement plans.
It’s very important for companies to make note of this now because many companies will need to start going through their employee census data to identify the part-time employees that will become eligible for the 401(K) plan on January 1, 2024. Failure to properly notify these part-time employees of their eligibility to participate in the plan could result in plan compliance failures, DOL penalties, and it could require the company to make a mandatory employer contribution to those employees for the missed deferral opportunity.
Full-time Employee Restriction
Prior to the passing of the Secure Act 1.0 in December 2019, 401(K) plans were allowed to limit participation in plans to employees that had completed 1 year of service which is commonly defined as 12 months of employment AND 1,000 hours worked within that 12-month period. The 1 year wait with the 1,000 hours requirement allowed companies to keep part-time employees who work less than 1,000 hours from participating in the company’s 401(k) plan.
Secure Act 1.0
When Congress passed Secure Act 1.0 in December 2019, it included a new provision that requires 401(K) plans to cover part-time employees who have completed three consecutive years of service and worked 500 or more hours during each of those years to participate in the plan starting in 2024. For purposes of the 3 consecutive years and 500 hours requirement, companies are only required to track employee service back to January 1, 2021, any services prior to that date, can be disregarded for purposes of this new part-time employee coverage requirement.
Example: John works for Company ABC which sponsors a 401(k) plan. The plan restricts eligibility to 1 year and 1,000 hours. John has been working part-time for Company ABC since March 2020 and he worked the following hours in 2021, 2022, and 2023:
2021 Hours Worked: 560
2022 Hours Worked: 791
2023 Hours Worked: 625
Since John had never worked more than 1,000 hours in a 12-month period, he was never eligible to participate in the ABC 401(k) plan. However, under the new Secure Act 1.0 rules, ABC would be required to allow John to participate in the plan starting January 1, 2024, because he works for three consecutive years with more than 500 hours.
Excluded Employees
The new part-time employee coverage requirement does not apply to employees covered by a collective bargaining agreement or nonresident aliens. 401(K) plans are still allowed to exclude those employees regardless of hours worked.
Employee Deferrals Only
For the part-time employees that meet the 3 consecutive years and 500+ hours of service each year, while the new rules require them to be offered the opportunity to participate in the 401(k) plan, it only requires plans to make them eligible to participate in the employee deferral portion of the plan. It does not require them to be eligible for EMPLOYER contributions. For part-time employees who become eligible to participate under these new rules, they are allowed to put their own money into the plan, but the company is not required to provide them with an employer matching, employer non-elective, profit sharing, or safe harbor contributions until that employee has met the plan’s full eligibility requirements.
In the example we looked at previously with John, John would be allowed to voluntarily make employee contributions from his paycheck but if the company sponsors an employer matching contribution that requires employees to work 1 year and 1,000 hours to be eligible, John would not be eligible to receive the employer matching contribution even though he is eligible to make employee contributions to the plan.
Secure Act 2.0
Up until now, we have covered the new part-time employee coverage requirements under Secure Act 1.0. However, in December 2022, Congress passed Secure Act 2.0, which changed the part-time employee coverage requirements beginning January 1, 2025. The main change that Secure Act 2.0 made is it reduced the 3 Consecutive Years down to 2 Consecutive Years starting in 2025. Both still require 500 or more hours each year but now a part-time employee will only need to complete 2 consecutive years of 500 or more hours instead of 3 beginning in 2025.
Also in 2025, under Secure Act 2.0, for purposes of assessing the 2 consecutive years with 500 or more hours, companies only have to look at service dating back to January 1, 2023, employment before that date is excluded from this part-time employee coverage exception.
2024 & 2025 Summary
Starting in 2024, employers will need to look back as far as January 1, 2021, and identify part-time employees who worked at least 3 consecutive years with 500 or more hours worked in each of those three years.
Starting in 2025, employers will need to look at both definitions of part-time employees. The Secure Act 1.0, three consecutive years of 500 hours or more going back to January 1, 2021, and separately, the Secure Act 2.0, 2 consecutive years of 500 hours or more going back to January 1, 2023. An employee could technically become eligible under either definition.
Penalties For Not Notifying Part-time Employees of Eligibility
Companies should take this new part-time employee eligibility rule very seriously. Failure to properly notify part-time employees of their eligibility to make employee deferrals to the 401(K) plan could result in a plan compliance failure and the assessment of Department of Labor penalties. The DOL conducts random audits of 401(K) plans and one of the primary pieces of information that they typically request during an audit is for the employer to provide a full employee census file and be able to prove that they properly notified each eligible employee of their ability to participate in the company’s 401(K) plan.
In addition to fines for not properly notifying these new part-time employees of their ability to participate in the plan, the DOL could require the company to make a “QNEC” (Qualified Non-Elective Contribution) on behalf of those part-time employees which is a pure EMPLOYER contribution. Even though these part-time employees might not be eligible for other employer contributions in the plan, this QNEC funded by the employer is to make up for the missed employee deferral opportunity. The DOL is basically saying that since the company did not properly notify the employee of their ability to make contributions out of their paycheck, now the company has to fund those contributions on their behalf. They could assign the QNEC amount equal to the average percentage of compensation amount deferred by the rest of the employees covered by the plan which could be a very costly mistake for an employer.
Why The Rule Change?
There are two primary drivers that led to the adoption of this new 401(k) part-time employee coverage requirement. First, acknowledging a change in the U.S. labor force, where instead of employees working one full-time job, more employees are working multiple part-time jobs. By working multiple part-time jobs with different employers, while that employee may work more than 1000 hours a year, they may never become eligible to participate in any of their employer’s 401(K) plans because they were not considered full-time with any single employer.
This brings us to the second driver of this new rule, which is increasing access for more employees to an employer-based retirement-saving solution. Given the increase in life expectancy, there is a retirement savings shortfall issue within the U.S., and giving employees easier access to employer-based solutions may encourage more employees to save more for retirement.