by Edward Fronczkowski, CPA, Partner
Many defined contribution plans require participants to complete a period of service before becoming fully vested in matching or nonelective employer contributions. When an employee leaves a company and has an unvested portion of funds in the company’s defined contribution retirement, the employee forfeits those funds which he is not vested in, thereby creating a “Forfeiture”. The plan document will govern how forfeitures can be used. Typically, forfeitures can be used to pay for certain plan expenses such as: auditing, accounting, or recordkeeping fees, or fees for annual administration and compliance services. The forfeiture funds can also be used to reduce certain employer contributions to the plan, or they can be reallocated back to the remaining eligible participants as an additional contribution.
Sometimes plan administrators will place these funds in a suspense account and allow them to accumulate over several years. The Internal Revenue Code does not allow this practice. Revenue Ruling 80-155 states that a defined contribution plan will not be qualified unless all funds are allocated to participants’ accounts in accordance with a definite formula defined in the plan. This would preclude a plan from carrying over plan forfeitures to subsequent plan years, as doing so would defy the rule requiring all monies in a defined contribution plan to be allocated annually to plan participants. Revenue Ruling 84-156 states that forfeitures may be used to pay for a plan’s administrative expenses and/or to reduce employer contributions. Treasury Regulations §1.401-7(a) notes that forfeitures must be used as soon as possible to reduce employer contributions.
If your plan has forfeitures, you should review your practices to make sure that those forfeitures are being administered in accordance with the Internal Revenue Code. In addition, you should review your plan document to ensure that its terms are clear as to how forfeitures are to be handled. On January 18, 2017, the IRS issued proposed regulations that now permit the use of forfeitures to be used for Qualified Nonelective Contributions (“QNECs”) and Qualified Matching Contributions (QMACs). You will want to ensure that the language in your plan document is consistent with this change to allow you to use forfeitures in that way should you desire to in the future. We are clarifying information regarding this topic since there seems to be a lot of misinformation about forfeitures.
If you have questions please contact your Maillie LLP representative.