IRS Proposed Regulations: Retirement Plan Forfeitures
Forfeitures generally arise when a participant has a severance from employment before completing the requirements for full vesting under the terms of the plan. In defined contribution plans, forfeited amounts are typically used to pay reasonable plan administrative expenses, reduce future employer contributions or are reallocated among other eligible participants. Currently, forfeitures in a defined benefit pension plan cannot be used to increase the benefits of other participants. For either plan type, the deadline for using forfeitures has never been clear. In an effort to provide clarification on the use and timing of forfeitures, the IRS recently released proposed regulations that will be effective for plan years beginning on or after January 1, 2024 (however, plan sponsors may rely on it in the interim). While the rules likely will not change how plan sponsors, advisers, and administrators are currently operating, they will make the process clearer.
Under the proposed regulations, forfeitures for defined contributions plans can be used for one or more of the following purposes: (1) pay plan administrative expenses, (2) reduce employer contributions under the plan and/or (3) increase benefits in other participants’ account in accordance with plan terms. The proposed regulations also require forfeitures to be used no later than 12 months after the close of the plan year in which forfeitures are incurred. The purpose of this deadline is to ease administrative burdens and simplify administration.
For defined benefit pension plans, the proposed regulations eliminate the existing requirements that forfeitures must be used as soon as possible to reduce employer contributions because it is inconsistent with the minimum funding requirements. Defined benefit pension plans must still provide that forfeitures may not be applied to increase the benefits of any other participants, but the effect of the forfeitures may be anticipated in determining the costs of the plan for minimum funding purposes.
Plan Provider Next Steps
The new proposed regulations provide some flexibility for plan administrators, but some plans may need to be amended eventually (assuming the proposed regulations are finalized in their current form). In the meantime, in light of the proposed regulations, plan sponsors should:
- Review the terms of their plan document regarding the use of forfeitures;
- Determine if their plan has forfeitures and, if so, the plan year(s) the forfeitures arose; and
- Analyze whether forfeitures are being administered in accordance with the terms of the plan and current law (in particular, whether forfeitures are being used timely and for proper purposes).
If it is discovered that forfeitures are not being administered properly, there are opportunities to correct the error(s).
Please contact us if you have questions about the information outlined above, our seasoned and experienced employee benefit plan professionals are here to help. You can also learn more about our Employee Benefit Plan Audit services by visiting our website.