The IRS recently issued proposed regulations that address how and when forfeitures must be used in both defined contribution (DC) and defined benefit (DB) retirement plans. Previously issued guidance was vague and may have resulted in some DC plan sponsors following practices that the IRS viewed as impermissible under the Internal Revenue Code (e.g., placing forfeited amounts into a plan suspense account and allowing them to accumulate over several years).
The proposal would be effective for plan years beginning on or after January 1, 2024. However, a transition rule is included under which forfeitures incurred during a plan year that begins before January 1, 2024, will be treated as having been incurred in the first plan year that begins on or after January 1, 2024. Employers may rely on these proposed regulations for periods before the applicability date.
A “forfeiture” is the amount left behind (i.e., the non-vested portion) after a participant in a qualified retirement plan leaves employment before completing the service required for full vesting. Over the years, the IRS has issued little guidance on how and when forfeitures must be used. In a 2010 newsletter, the IRS informally discussed that DC forfeitures must be used or allocated in the plan year incurred and could not be placed in a suspense account to accumulate over future years; however, in the same document, the IRS seemed to indicate that forfeitures could be held until the end of the following plan year for plans that use the forfeitures to pay plan expenses or reduce employer contributions (as opposed to using them to increase participant benefits). In any case, it was clear that the IRS wanted plan documents to describe how and when a plan could use or allocate plan forfeitures.
To formally clarify the former guidance and align it with the IRS view expressed in 2010, the proposed regulations provide that forfeitures incurred under a DC plan must be used within 12 months following the close of the plan year.
Under the proposed rules, DC plans may use forfeitures to:
The IRS notes that “[a]lthough nothing in the proposed regulations would preclude a plan document from specifying only one use for forfeitures, the plan may fail operationally if forfeitures in a given year exceed the amount that may be used for that one purpose,” and that “[t]he plan could avoid this failure if it were amended to permit forfeitures to be used for more than one purpose.”
The proposed regulations also update the rules relating to the use of forfeitures in DB plans to reflect current IRS minimum funding requirements that apply to DB plans. The proposal also eliminates the requirement that forfeitures under pension plans be used as soon as possible to reduce employer contributions, because it is inconsistent with those minimum funding requirements. Instead, reasonable actuarial assumptions are used to determine the effect of expected forfeitures on the present value of plan liabilities and normal costs under the plan’s funding method. Differences between actual forfeitures and expected forfeitures increase or reduce the plan’s minimum funding requirement for future years pursuant to the plan’s funding method. Since this clarification already comports with current practice regarding forfeitures in DB plans, it would not affect plan funding or administration.
DC plan sponsors should review the language in their plan documents to determine whether forfeitures are being reallocated and/or used to cover plan expenses and/or to reduce employer contributions, all within 12 months following the close of the plan year. If plan documents are silent with respect to forfeitures or are inconsistent with the proposed rules, they should be amended to come into compliance with the IRS’s guidance. DC plan sponsors may also want to amend their plans to expand the permitted uses of forfeitures. In addition, employers should make sure that their recordkeepers are complying with the updated rules.
DB plan sponsors should ensure the language in their plans indicate that forfeitures cannot be used to increase participant benefits before plan termination.
| Title | File Type | File Size |
|---|---|---|
| Insider April 2023 | .2 MB |
