Most employers exclude some employees from their 401(k) plans and, to a lesser extent given the strict universal availability requirements, their 403(b) plans. Doing so has always been permissible as long as the exclusions are reasonable and nondiscriminatory. As a result, exclusions based on bona fide, job-based classifications are typically permitted. However, things get a little more complicated when that job-based classification relates to the amount of time someone spends working for the business.
This is because the Internal Revenue Service (IRS) has indicated that it does not consider class-based exclusions of part-time, seasonal or temporary employees to be reasonable. Instead, the IRS views those exclusions as a proxy for imposing backdoor service-based conditions on plan participation that are not otherwise permitted under the tax code. Put another way, the IRS sees attempts to impose a class exclusion on these employees as a way to circumvent the rules that otherwise require employers to let employees in their plans after they perform a requisite period of service.
The new long-term, part-time employee rules under the SECURE Act and the SECURE 2.0 Act do not change this. This means employers can still exclude employees from their plans based on job function or location as long as the exclusion represents a bona fide and nondiscriminatory class exclusion and is not a proxy for imposing an otherwise impermissible service condition. For example, if most part-time-type employees are performing the same job function or work at the same location, an employer could theoretically exclude all employees who perform that same job function or work at the same location from its 401(k) plan without violating the tax code’s minimum service rules (as long as the plan can still pass required nondiscrimination testing). But—and this is a big but—some IRS representatives have indicated that even criteria like job function and work location that are not service-based may still violate the tax code if they merely disguise an improper service rule.
As a result, the new long-term, part-time employee rules have generated renewed interest in the application of the class exclusion rules, for example as they relate to groups like summer interns or co-op employees. This is especially true in situations where employers are using believed-to-be bona fide class exclusions but have also historically taken comfort in knowing the employees subject to any service-adjacent exclusions will never work more than 1,000 hours in a designated 12-month period. With the hours threshold for participation changing, it is as important as ever for employers to revisit their existing eligibility exclusions to ensure that they continue to be primarily job and not service-based.
