On May 18, 2016, the U.S. Department of Labor (DOL) issued the final version of a highly anticipated new rule revising overtime regulations of the Fair Labor Standards Act (FLSA). The new rule, taking effect on Dec. 1, 2016, modifies in a number of important respects the FLSA’s “white collar” overtime exemptions. The modifications generally will expand the categories of workers eligible for overtime protection under the FLSA. In preparing for the new rule taking effect, employers should consider potential implications for their employee benefit plans.

Significant Changes Made by New Rule

The new rule makes the following significant changes:

  • The salary-level threshold for most overtime-exempt employees (the “white collar” exemptions) will more than double from $455 per week to $913 per week ($23,660 to $47,476 per year).
  • The salary-level threshold for the “highly compensated” employee exemption will increase from $100,000 per year to $134,004 per year.
  • These figures will be automatically updated by the DOL every three years to maintain consistency and keep pace with inflation. The first update will occur Jan. 1, 2020, at which time the white collar salary-level test is expected to reach more than $51,000.
  • Up to 10 percent of an employee’s standard salary level can come from non-discretionary bonuses, incentive payments and commissions, paid at least quarterly. This new provision allows employers to take advantage of certain non-salary payments to help reach the required threshold.

The cumulative effect of these changes will be to expand the categories of employees eligible for overtime protection under the FLSA. In response to this, employers will need to evaluate positions that are compensated below the new threshold to estimate potential additional overtime costs, and consider whether raising salaries, reclassifying employees or other changes should be implemented to minimize such additional costs. For more information regarding the new rule, see prior McGuireWoods Legal Alerts of May 18, 2016 and June 13, 2016.

How New Rule May Affect Employee Benefit Plans

Employers should evaluate what implications the new rule, and any changes they plan to make in response to the new rule, will have on their employee benefit plans.

Overtime as a Component of Compensation in Retirement Plans

For example, an employer may anticipate that, based on its workforce and compensation practices, it will experience material increases in the overtime wages as a result of the new rule. If the employer sponsors a 401(k), pension or other type of tax-qualified retirement plan that uses a definition of compensation for computing contributions and benefits that includes overtime pay, anticipated increases in projected overtime wages may materially increase benefits costs as well.

Observation: A plan’s definition of compensation may include overtime pay without specifically referring to it. For example, many plans use a definition of compensation based upon Form W-2, Box 1 wages, with adjustments. Overtime pay will be included in compensation under such a definition absent a specific exclusion.

Alternatively, the employer’s retirement plans may use a definition of compensation that specifically excludes overtime pay (or the employer may want to consider amending its plans to add such an exclusion prospectively). However, excluding overtime pay in computing compensation and benefits under a tax-qualified retirement plan generally is permissible only to the extent that the compensation taken into account under a plan can satisfy nondiscrimination testing requirements. Employers that expect a material increase in overtime wages as a result of the new rule, and that have plans already excluding overtime pay, should determine now whether projected increases in overtime wages could affect their plans’ ability to continue to meet these nondiscrimination requirements.

Employers that decide to modify a retirement plan’s compensation definition to exclude overtime pay will need to consider, in addition to nondiscrimination testing, other legal and operational issues. For example, the modification may need to be coordinated with the start of a plan year, such as in the case of a “safe-harbor” 401(k) plan. In addition, time may be needed to modify payroll systems and plan administrative processes to accommodate the new pay exclusion.

Effect of Reclassification of Employees

Reclassification of employees in response to the new rule also may have implications for an employer’s benefit plans. For example, an employer’s plans should be reviewed to determine whether they condition eligibility based on position (such as on salaried versus hourly paid). Modifications to the terms of those plans may be necessary to continue to provide current benefit levels.

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The employee benefit plan issues created by the new rule will vary from employer to employer. Careful coordination between an employer’s compensation and benefits specialists will ensure that these issues are identified sufficiently in advance so that options for addressing the impact of the new rule can be considered, and decisions timely implemented.