Expanded 401(k) eligibility is taking businesses by surprise

Potentially millions more long-term, part-time employees are now eligible to join 401(k) retirement plans, thanks to recent legislation, and there's a new method of counting defined contribution retirement plan participants on the Form 5500 Annual Return/Report that accountants, their clients and companies will need to know.

The Setting Every Community Up for Retirement Enhancement Act of 2019 (also known as the SECURE Act) expanded long-term, part-time employee access to employer retirement plans by requiring 401(k) plans to allow employees that meet the LTPT requirements to make elective deferrals starting with the first plan year beginning on or after Jan. 1, 2024. It's important to understand the new rules because LTPT employee eligibility can potentially affect two other administrative functions for plan sponsors: Form 5500 filing and the annual employee benefit plan audit requirement. 

"It's hard to believe it, but it took people by surprise," said Norma Sharara, managing director of BDO USA's National Tax Office, Compensation & Benefits. "The change in the law happened in 2019 in December, and the law said, if your employees have worked more than 500 hours of service in 2021, you have to start counting people [for] 2021, 2022 and 2023. If they had 500 hours in each of those three consecutive years on January 1, you have to let them into your plan. Well, the rules on telling you how to do this came out the Monday after Thanksgiving 2023, so people were still digesting their Thanksgiving leftover turkey sandwiches, and they got this very complicated set of rules from the IRS in November 2023 and had very little time to absorb the guidance to effectively let people in on Jan. 1, 2024. So people either ignored it or missed it or weren't aware. It was less than 30 business days the IRS had given people on this guidance."

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Before 2023, Form 5500, which is an essential part of the reporting and disclosure framework under the Employee Retirement Income Security Act of 1974 (or ERISA for short), required defined contribution retirement plan sponsors to include employees who were eligible to make elective deferrals on the first day of the plan year. Now, thanks to the SECURE ACT, employers only need to include participants with an account balance in the defined contribution retirement plan as of the first day of the plan year. However, for new plans, the participant account balance count is determined as of the last day of the first plan year. 

"What we're finding is a lot of folks in the part-time workforce — restaurants, hospitality [businesses], ski resorts, beach resorts, amusement parks, seasonal industries that have dedicated employees who work year after year for that employer on a part-time basis — are now allowed to save their own money," said Sharara. "The employer doesn't have to match it, but they have to be allowed to get in. And the rule for 50 years since ERISA has been around was you can keep people out of your 401(k) plan if they're not yet age 21 and don't have 1,000 hours. Most of these part-time workers never rang the bell on a thousand hours and never got to save their own money, and they changed these rules in the SECURE Act to increase access to workplace retirement savings." 

The advent of gig economy jobs means many more people now have multiple part-time jobs but still need to plan for retirement. 

"Congress thought it was really important to let people save their own money through a workplace retirement plan," said Sharara. "But what we're seeing now is it snuck up on people, and it's costing employers a lot to get into compliance with something they may have missed. So we are trying to get the word out. It's better not to have a problem. It's better to comply. But if you've missed it, there's a path to good because the IRS has an amnesty program that can help employers set things right and get back on the right path."

The amnesty program is known as the Employee Plans Compliance Resolution System. 

"Technically, if you don't follow these new rules, the plan is disqualified, which is an atomic bomb result, and nobody wants that," said Sharara. "The amnesty program is called EPCRS. You can fix the problem, self-correct and get back on the path to good. It's better not to make a mistake, but if you did make a mistake, it's not the end of the world. Timely correction is the way to go, and there are a lot of implications if they miss it."

The change will increase the headcount for plan participants at many companies, and auditors will need to be aware of those changes as well. 

"If we kept with the old 5500 headcount rule, it could really cause people a lot of expense because they'd have to go get an audit because these people are eligible, even if they didn't defer," said Sharara. "And if they now use the new rule, well, not only are you eligible, but you have to have an account balance in order to count toward the participant headcount. And it's important for auditors to understand this is a big, big thing to have the headcount rule change for the Form 5500. You need an independent financial audit if your plan has 100 or more participants as of the first day of the year. It's a new methodology starting with the 2023 Form 5500 that I think most accounting people know, but the devil's in the details. How do you sync that up with the long-term part-time employee rule, and the headcount rule for the Form 5500?"

She has been hearing questions about the implications of the new rule and how it will be affecting more organizations in the future, including those with 403(b) plans. 

"These rules have changed for the headcount on the 2023 Form 5500, and the long-term part-time participant rules have come online starting 2024," said Sharara. "And then it gets even worse for 2025 403(b) plans, which are maintained by K-12 schools, governments and tax-exempts — 403(b) plans have to start following the long-term part-time employee rule on Jan. 1, 2025, and that will impact them."'

The changes keep coming

There were even more changes in the successor to the SECURE Act, dubbed SECURE 2.0, which was part of a wider-ranging package of tax and retirement changes that Congress passed at the end of 2022. 

"In SECURE 2.0, Congress in December 2022 said, 'You know what, we love the long-term, part-time employee rules so much that we're going to reduce the three-year eligibility down to two years,'" said Sharara. "Starting in 2025, if you have anyone who worked 500 hours or more for two years, then you have to let them into the plan to save their own money. The [Form] 5500s for 2023 have this change now, and it's going to get worse next year. It is a really big shakeup of rules that have been around for a long time."

Retirement plans that don't comply with the new rules could end up being disqualified.

"Tax-qualified retirement plans can keep their tax-exempt status only if they follow all of the many rules in order to keep their status," said Sharara. "Failing this, the long-term part-time rule will disqualify the whole plan. It's an atomic bomb penalty for a foot fault."

Fortunately, there is an amnesty program available, giving companies and their accountants the opportunity to address any compliance problems during this grace period.

"The plan documents are not required to be updated for most plans until the end of the 2026 plan year," said Sharara. 

However, accountants should not wait to tell their clients and companies about the change, but should warn them as soon as possible, since many employers just rely on an outside document provider to take care of any changes.

"A lot of employers just count on their document provider," said Sharara. "If you don't get that document until the end of the 2026 plan year, and they probably don't even know what's in it, the plan document still says the old rule. It doesn't say anything about this. But in operation, the rules for tax-qualified plans say you have to operate in accordance with the change in the law, by the effective date, in this case, 2024. They're relying on somebody to tell them they need to do something, if nobody has poked them and told them, 'Hey, do you have part-time people, and if so, this is not an option, this is a mandate.'"

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