How Employers Can Use Plan Forfeiture Funds
By Leslie Valenzuela
What is a forfeiture account in a qualified retirement plan?
When a plan participant with a balance in a qualified retirement plan terminates employment and is not fully vested, the nonvested amount is moved to a holding account, referred to as a forfeiture account. These assets are moved on a date specified in the plan document and are to be used in accordance with the plan provisions.
If a plan has a balance in its forfeiture account, how can the employer use the forfeiture account funds, and by when do they need to be used?
The plan document will specify how the employer may use the plan’s forfeiture funds. They may be
used to pay allowable administrative expenses,
used to reduce employer contributions,
reallocated as an employer contribution, or
restored to participants upon rehire.
Forfeitures must be used up each year based on the timing specified in the plan document. In the Retirement News for Employers, spring 2010 edition, the IRS noted that “audit experience illustrates some plans inappropriately allow forfeitures to accumulate for several years, when, in fact, forfeitures are to be exhausted during the plan year in which they are incurred, or no later than the following plan year in appropriate circumstances. Employers should review the plan language and associated administrative procedures to make sure they are using forfeitures in accordance with their plan document and within the specified deadline that applies to their plan.”
It is important that forfeitures be handled properly, as both the IRS and Department of Labor generally will review this during an audit.
A plan has forfeitures that go back a few years. How should this be fixed?
Not applying forfeitures timely can create an operational failure, which may be corrected by using the IRS’ Employee Plans Compliance Resolution System (EPCRS). To fix a failure within two plan years following the close of the plan year in which the mistake occurred, employers can use the Self-Correction Program (SCP). Unless the failure can be classified as insignificant, the Voluntary Correction Program (VCP) should be used to correct failures occurring in plan years prior to this time.
The correction is to allocate the unused forfeiture amounts as indicated in the plan document to those participants who would have been eligible for such contributions in the year that the forfeitures should have been used. The correction will most likely require an adjustment for lost earnings. It might also require locating and distributing a forfeiture amount to a former participant who has since left employment, unless the forfeiture amount would be considered deminimis, or is less than a service charge that might be assessed for a distribution.
Can forfeitures be used to fund a corrective QNEC?
Yes. The IRS released final regulations in 2018 confirming that employers can use forfeitures to fund qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and 401(k) safe harbor contributions.