Long term part time employees and the "20 hour exclusion" in ERISA 403(b) Plans

[Belgarath]

So, I've seen various opinions on this.

One is that for purposes of DEFERRALS ONLY, (not employer contributions) the "less than 20 hour exclusion" is no longer valid at all, and therefore all employees must be allowed to defer under the universal availability rule, absent another valid exclusion category.

Another is that the "less than 20 hour" exclusion is still valid for deferrals, EXCEPT for LTPT employees. In other words, someone who works only, say,  6 hours per week could still be excluded for deferral purposes.

I'm not 100% sure which is correct. From a practical standpoint, since most plans (of ours, anyway) don't use the 20 hour exclusion anyway, it isn't a giant problem for most small plans regardless.

Thoughts?

[Peter Gulia]

Consider that an answer might vary with whether the plan’s sponsor and administrator seek to meet only Internal Revenue Code § 403(b)(12)(A)(ii) or also seek to obey ERISA sections 202(c) and 203(b)(4).

Applicable or relevant law is ambiguous.

Forty comments on the Treasury’s proposed rule are available at https://www.regulations.gov/document/IRS-2023-0058-0001/comment.

Some comments flag your question as an open issue the Treasury’s proposed rule does not resolve. Likewise, some comments flag a coordination between tax law conditions and ERISA’s minimum-participation and minimum-vesting provisions as an open issue the Treasury’s proposed rule does not resolve.

Although some might guess the Treasury lacks power to interpret ERISA § 202(c) and 203(b)(4), the 1978 Reorganization Plan transfers that authority to the Treasury. https://www.dol.gov/agencies/ebsa/laws-and-regulations/laws/executive-orders/4.

But even if the Treasury publishes a final rule and no court vacates the rule, a Federal court does not defer to an executive agency’s interpretation of the statute.

An ERISA-governed plan’s administrator must administer the plan according to the plan’s governing documents or, to the extent a document is inconsistent with ERISA’s title I, ERISA’s title I. That might call for an administrator’s prudent interpretations of ERISA sections 202 and 203.

Different law applies for a governmental plan or for a church plan that did not elect to be ERISA-governed.

[Belgarath]

Thanks Peter. I should have specified that I was talking only about ERISA 403(b) plans. You provide interesting discussion!

[Patricia Neal Jensen]

Re: ERISA 403(b) Plans:  We are still using the 20 hour exclusion for deferrals etc. when the sponsor requests, but informing the sponsor that it will be "overridden" by the LTPT rules.  It can be complex and messy.  We do discourage the use of the 20 hour exclusion because of LTPT but this argument is not acceptable to all sponsors who want to use it.  I know of no ruling that invalidates use of the 20 hour exclusion in the plan document.

[Carol V. Calhoun]

I would also say that most of our employers have simply decided to allow all employees, regardless of hours, to make their own contributions (although part-timers may not be eligible for a match or nonelective contributions).  The cost of allowing employees to contribute their own money is typically less than the cost of keeping two or three years' worth of records of hours.

[Belgarath]

Agreed - we discourage it as well, and actually have very few plans that use it. But, we have one plan, for example, that has over 150 part timers who work less than 500 hours, and dealing with all of them as eligible to defer is more of a pain than dealing with the rare LTPT (about 1/2 dozen) exceptions to the exclusion. 

IMHO, extending this to 403(b) plans was one of the more obnoxious provisions (among many) of SECURE 2.0.

[EBECatty]

This also appears to be an issue with the student-employee exclusion. Aside from the fact that this exclusion appears in the same sentence as the 20-hour exclusion, subjecting student employees to the LTPT rules seems less logical to me, particularly as the student-employee exclusion is less connected to hours of service than the 20-hour exclusion, and the proposed regulations allow non-hours-based categories of employees to be excluded even if they exceed the 500-hour threshold in two years.

Some comments flag this issue too. 

I'm interested to hear what position others are taking on whether a student employee who works 500 hours (but not 1,000) in two consecutive years must be eligible to defer. 

[Peter Gulia]

These hyperlinks point to some BenefitsLink discussions about whether an employment classification is or isn’t a proxy for an age or service condition.

https://benefitslink.com/boards/topic/71371-ltpt-proposed-regs-issued-by-irs/#comment-334692

https://benefitslink.com/boards/topic/71384-ltpt-interns/

I can’t yet share a reasoning; here’s why:

Not all plans are burdened by a command or condition to let a long-term part-time employee defer.

Some plans allow every employee to defer.

A plan’s administrator might not decide whether a particular employment classification’s exclusion is permissible until it becomes necessary to decide.

Whether “[a] condition is not a proxy for imposing an age or service condition that requires” more than what meets the LTPT condition (if the plan’s administrator considers that reasoning) is highly fact-sensitive.

Different clients have different appetites for risk or caution.

Different clients have different aptitudes and interests about whether it’s important to maintain an exclusion for an employment classification.

[EBECatty]

Peter, all good points. I'm thinking more generally based on the revised statutory language, particularly the interpretation discussed here:

FLASHPOINT: Nerding Out on SECURE 2.0: Long-Term Part-Time, and 403(b) Plans – Ferenczy Benefits Law Center - We are your ERISA solution (ferenczylaw.com)

I don't believe we've been given a clear answer from the IRS, so I'm curious what others are thinking and/or recommending at this point (and, of course, not seeking a legal opinion specific to this sponsor).

The sponsor here will be affected by this rule starting in 2025; excludes student employees from deferring; correctly characterizes only students as student employees and does not otherwise use the categorization as a proxy for age/service; has some students who work under 500 hours, some who work 500-1,000, and some who work over 1,000; and wants to continue excluding them from deferring to the extent permissible by law (which would affect largely the 500-1,000 hours group on this issue).

This fact pattern seems to squarely face this question and how to interpret. 

[Belgarath]

FWIW - I think you can continue to use the exclusion, BUT, it cannot serve to exclude (from making deferrals) those students who work the 500-1,000 that you mention.

[Peter Gulia]

EBECatty, consider whether to suggest your client not amend the plan until applicable law becomes clearer or tax law’s remedial-amendment period soon will end, whichever happens first. (Alternatively, one might write a provision that the plan’s student exclusion does not apply to the extent that ERISA § 202(c) commands that the exclusion not apply.)

Before an amendment, a plan’s administrator might interpret the plan to include (only) the provision ERISA § 202(c) commands.

See, for example, Lefkowitz v. Arcadia Trading Co. Ltd. Benefit Pension Plan, 996 F.2d 600, 604 (2d Cir. 1993) (for a defined-benefit pension plan that omitted to provide for a qualified preretirement survivor annuity, the court interpreted the plan as providing a QPSA); Gallagher v. Park West Bank & Tr. Co., 921 F. Supp. 867 (D. Mass. 1996) (for an individual-account retirement plan that omitted to state any qualified preretirement survivor annuity or other survivor provision, the court interpreted the plan as providing a 50% QPSA); see also, by analogy, Laurent v. PricewaterhouseCoopers LLP, 945 F.3d 739 (2d Cir. 2019) (If a plan’s document states a provision contrary to ERISA’s title I, a court may reform the plan.)

Remember, ERISA § 404(a)(1)(D)’s charge to administer a plan “in accordance with the documents and instruments governing the plan” applies only “insofar as such documents and instruments are consistent with the provisions of [ERISA] title [I][.]”

While one administers the plan by interpolating ERISA § 202(c), that fiduciary would form prudent interpretations about what ERISA § 202(c) commands (or doesn’t).

The potential exclusion would apply only for “a student who is enrolled and regularly attending classes at [the] school, college, or university[.]” I.R.C. (26 U.S.C.) § 3121(b)(10). So, if you’re seeking to compare your potential interpretations (several interpretations might be within an administrator’s discretion) to other lawyers’ interpretations, you might prefer them from one who has at least one college or university that employs students (and before 2025 excludes them elective deferrals).

This is not advice to anyone.

[Peter Gulia]

The Internal Revenue Service FOIA-released a Notice to state IRS and anticipated Treasury interpretations of Internal Revenue Code § 403(b)(12) and § 410(b), and of ERISA §§ 202-203.

Additional Guidance with Respect to Long-Term, Part-Time Employees, Including  Guidance Regarding Application of Section 403(b)(12) to Long-Term, Part-Time Employees under Section 403(b) Plans, Notice 2024-73, 2024-41 or 2024-42 I.R.B. --- (to be published Oct. 7 or 15, 2024), available at https://www.irs.gov/pub/irs-drop/n-24-73.pdf.

For an ERISA-governed § 403(b) plan, these interpretation distinguish between a 20-hours exclusion and a student exclusion. The IRS suggests: “The student employee exclusion . . . is . . . based on a classification . . . , rather than on service.” Under that interpretation, ERISA § 202(c) does not command a plan to make an I.R.C. § 3121(b)(10) student eligible to elect deferrals.

The Notice remarks: “The Secretary of the Treasury has interpretive authority over sections 202 and 203 of ERISA pursuant to Reorganization Plan No. 4 of 1978[.]”