The rate of change in the employment and benefits area seems to be accelerating. This alert addresses some of the changes that have been of most concern to our clients.
Observations on Long-Time Part-Time Employee Determinations
New Fiduciary Rule
Confused over the Status of Non-Competes? Join the Crowd
Minimum Wage and Overtime Changes
Massachusetts Pay Transparency Update
Observations on Long-Time Part-Time Employee Determinations
Employers sponsoring 401(k) plans must, generally beginning on or after January 1, 2024, allow so-called long-term part-time (“LTPT”) employees working between 500 and 1,000 hours of service for three consecutive years (two consecutive years for plan years beginning on or after January 1, 2025) to make elective deferral (401(k)) contributions. Employers need not, however, make employer contributions for any LTPT employees participating in the plan.
As we have discussed in prior advisories, the SECURE Act first added the concept of an LTPT employee and SECURE 2.0 Act made various modifications, including expanding the LTPT requirements to certain 403(b) arrangements. In late November 2023, long-awaited proposed regulations were issued (the “Proposed LTPT Regulations”). As we await final regulations, we wanted to highlight a few of the thornier issues that the Proposed LTPT Regulations raise. Our focus here is on 401(k) plans (rather than 403(b) arrangements).
Employee Category Exclusions. For close to 20 years, little has changed in the way of eligibility exclusions involving certain categories of employees, such as temporary, casual or seasonal employees or interns. In general, provided the “minimum coverage” (Internal Revenue Code Section 410(b)) requirements can be satisfied, it is possible to exclude these employees from participation in a qualified plan.
The wrinkle has long been whether the Internal Revenue Service might view such exclusions as an end-run around the most often used maximum age and service eligibility requirements of age 21 and one year of service, the latter generally consisting of a 12-month period in which the employee performs at least 1,000 hours of service. Some, but not all, employers have added “backstop” provisions that allow such employees to enter the plan upon satisfying an age 21/one year of service requirement.
By our reading, the Proposed LTPT Regulations appear to have upped the ante a bit on certain categorical exclusions by explicitly providing that any elective deferral eligibility exclusion that is a “proxy” for imposing an age or service requirement is prohibited. Establishing this rule in the form of a regulation strengthens the Internal Revenue Service’s hand and may signal renewed scrutiny of category exclusions. At a minimum, the Proposed LTPT Regulations shift the risk/reward calculus on excluding categories of employees.
Pros and Cons of LTPT Status. What is striking to us in speaking with clients is that the best strategy for dealing with LTPT employees is not the same across clients and plans. Allowing LTPT employees to participate in the elective deferral contribution feature does have its advantages. In addition to not having to make employer contributions (such as a match or profit sharing contribution), a plan sponsor can elect to disregard them for purposes of the minimum coverage test, the ADP and ACP test (or safe harbor provisions), tests under Internal Revenue Code Section 401(a)(4) (including benefits, rights and features testing), and, interestingly, catch-up contributions. The election is all-or-nothing, meaning that either all LTPT employees must be included for all testing purposes or none of them are included for any applicable testing purposes. In addition, if the election is made, the employer will also exclude LTPT employees from any top-heavy vesting and contribution provisions, although their balances will be taken into account in determining whether or not a plan is top heavy.
One wrinkle introduced by the Proposed LTPT Regulations is the rejection of the use of the elapsed time method for determining eligibility, a method created to allow employers an alternative to tracking hours. Instead, the Proposed LTPT Regulations require an employer to either actually count hours or use an equivalency method if a plan sponsor wants to take advantage of an individual’s LTPT status. And because only an employee who meets the definition of an LTPT employee is eligible to be excluded from employer contributions and for the various testing purposes described in the preceding paragraph, at least some employers who use the elapsed time method for plan purposes exclusively will need to invest in payroll and/or recordkeeping system changes if they want to take advantage of the benefits of the LTPT provisions.
LTPT Vesting. Perhaps the most significant disadvantage of LTPT status, however, are the special vesting rules introduced by the Proposed LTPT Regulations. An LTPT employee is entitled to credit for each year of vesting service for which the individual completes at least 500 hours of service. The Proposed LTPT Regulations go a step further, however, by requiring a former LTPT employee to continue to receive vesting credit based on a 500-hour standard. That is, even if an LTPT employee moves to a fully eligible plan participant category, the individual is permanently entitled to be credited vesting service for each year in which the employee completes 500 hours of service. This means an LTPT/former LTPT employee will always be treated better than a “regular” employee for vesting purposes. Not surprisingly, employer groups and recordkeepers have commented on this provision, noting in particular that it is not necessarily supported by the law.
Plan Design Considerations. The appropriate plan design for any particular client will depend on the plan’s current design and the employee population. For example, a plan with generous eligibility and vesting provisions and employer contributions may benefit from allowing employees who meet the LTPT requirements into the plan as LTPTs. This provides the employees with an elective deferral opportunity without the additional cost of employer contributions or adverse testing consequences. (And if participants are otherwise fully vested, no special tracking would be required.)
Another scenario involves an employer that might be reaching the limit on the number of employees that can be excluded under the minimum coverage requirements. Shifting to an LTPT employee approach may relieve the pressure at little incremental cost – aside from administrative hassles and the aforementioned vesting benefit.
Other employers may decide that the continued exclusion of interns, seasonal, casual or other types of temporary employees may simply no longer be worth the risk of a challenge and the new rules afford the opportunity to make a change.
Finally, some plan sponsors may simply find that letting all employees make elective deferrals after one year of service (or earlier) using the elapsed time method (or immediately) reduces the administrative burden of having to track LTPT hours, even if it results in the requirement to make employer contributions, the incremental cost of which may be mitigated by the plan‘s vesting schedule.
Next Steps. For plans utilizing a calendar year plan year, the earliest year an LTPT employee would be eligible to make elective deferrals is 2024 as a result of having had at least 500 hours in each of 2021, 2022 and 2023. If a plan has not complied with the new law, self-correction is a viable option, as long as the error is caught early enough. Plan amendments relating to the LTPT changes, including design changes intended to avoid application of LTPT rules, will need to be made no later than the last day of the 2025 plan year. Hopefully final, and potentially revised, regulations will be issued well before then.
New Fiduciary Rule
As part of the continuing saga around efforts by the Department of Labor to expand the definition of fiduciary under ERISA, the Department finalized its amendments to regulations defining investment advice under ERISA Section 3(21). The new regulations were accompanied by changes to certain related prohibited transaction class exemptions.
The new regulations adopt a two part test by defining an investment advice fiduciary as anyone who undertakes an investment transaction or makes a strategy recommendation for a fee (or other direct or indirect compensation) and either: (a) directly or indirectly (for example, through an affiliate) makes professional investment recommendations to investors on a regular basis as part of their business, and the particular recommendation is made under circumstances that would indicate to a reasonable investor that the recommendation is based on a review of the investor’s particular circumstances or needs, and may be relied upon to advance the investor’s best interest; or (b) the person represents or acknowledges that they are acting as a fiduciary under ERISA.
This is the Department of Labor’s third attempt to expand this regulation and lawsuits seeking to overturn it have been filed. As with the Department’s prior attempts, the new regulation significantly broadens the number of people who will become investment advice fiduciaries and the types of advice that will be considered fiduciary advice (including, for example, retirement plan/IRA distribution and rollover advice). The new rule also generally attempts to move advisors toward a single principles-based prohibited transaction class exemption approach that requires, among other things, an affirmative statement that the advisor is a fiduciary, provides for expanded disclosures, requires additional internal practices and procedures and includes a requirement that the advisor meet certain standards of care and loyalty.
The new rule was slated to be effective September 23, 2024, with a one-year phase-in. But a Texas federal district court just issued a stay delaying the effective date of the regulation indefinitely.
Even if it ultimately becomes effective, the new rule should not directly impact plan sponsors and plan administrators, other than that they will receive revised disclosures from existing advisors. In reviewing advice arrangements, plan sponsors and plan administrators will always want to inquire about the advisor’s compliance with applicable regulations and prohibited transaction class exemptions as part of satisfying their own general ERISA fiduciary obligations to monitor fiduciary performance.
Confused over the Status of Non-Competes? Join the Crowd
Earlier this year, the Federal Trade Commission (“FTC”) issued a near-total ban on non-competes that is scheduled to take effect on September 4, 2024. There are real questions as to whether the FTC has the authority to issue a rule in this area, and even if it does, whether this rule is “arbitrary and capricious.”
There are several federal cases challenging the rule, and so far, two courts have reached conflicting conclusions. A federal court in Texas ruled against the ban but declined to issue nationwide injunctive relief, leaving individual employers and workers to decide how to respond to the rule. Just weeks later, a federal court in Pennsylvania ruled in favor of the ban.
Employers that intend to comply with the rule have until September 4 to provide notice to workers, who are currently subject to non-competes, that their non-competes are unenforceable and will not be enforced. (For more on the substance of the rule, read more here; for more on the Texas decision, read more here; for more on the Pennsylvania decision, read more here).
The FTC ban is not the only federal attempt to limit non-competes. The General Counsel for the National Labor Relations Board (“NLRB”), which enforces the National Labor Relations Act (“NLRA”), has taken the position that non-compete agreements generally violate the NLRA. This position has not been formalized in a regulation, and the NLRB’s authority is generally limited to employees in non-supervisory, non-managerial roles. Additionally, the Antitrust Division of the U.S. Department of Justice commented in favor of the FTC’s non-compete ban, and regardless of the ban’s fate, the Department may increase its attention to non-competes.
With an unsettled federal landscape, state-level approaches, which vary widely, remain important. On one end of the spectrum are the states that outright ban almost all non-competes. On the other end are states that allow non-competes that are reasonably tailored to protect legitimate business interests—a somewhat subjective concept defined through judicial decisions. In between these two poles are the states that have set specific guardrails on non-competes. These guardrails vary significantly by state but may include, for example: presumptions about what is (or is not) a reasonable length for a non-compete; procedural requirements before a worker signs a non-compete; mandatory consideration in exchange for a non-compete; and bans on non-competes for certain groups of workers (such as hourly workers, workers earning below a certain threshold, workers in certain professions or workers who have been laid off). Because the FTC ban remains vulnerable, employers and workers should be aware of these state-level rules.
Minimum Wage and Overtime Changes
The U.S. Department of Labor (“DOL”) has significantly heightened pay requirements for employees to be exempt from overtime. For most employees, the previous minimum salary of $684 per week ($35,568 per year) has been increased to $844 per week ($43,888 per year) effective July 1, 2024. An even larger increase is on the horizon; effective January 1, 2025, the minimum salary will be $1,128 per week ($58,656 per year). Additional requirements must also be satisfied.
Employees must now earn total annual compensation of $132,964 (up from $107,432) to qualify as a “highly compensated employee,” which if certain additional requirements are met also avoids the need to satisfy minimum wage and overtime requirements of federal law. Effective January 1, 2025, the amount is further increased to $151,164.
In addition to federal requirements, certain states impose their own minimum wage and overtime requirements with which employers must comply. These provisions often prevent, for example, compensating an employee solely with equity.
Massachusetts Pay Transparency Update
Finally, employers may be aware of a growing number of states that require them to provide information about their salary ranges. Last week, the Massachusetts legislature passed its own version of a pay transparency statute (H. 4890). Under the bill and beginning a year after the bill becomes law, public and private employers with at least 25 employees in Massachusetts will be required to include the expected pay rage for a position in a job posting and when offering a current employee a promotion or a transfer to a new position. Employers must also provide pay ranges to current employees and applicants upon request. Additionally, most employers with at least 100 employees in Massachusetts will be required to submit EEO and pay data to the Massachusetts Department of Labor. As of the publication of this alert, the bill had not yet been signed into law by Governor Healey, but it is anticipated that that will happen shortly.
