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Plan Forfeitures: Staying Compliant with IRS Regulations

By May 2, 2024No Comments

Retirement plans are permitted to have a “vesting schedule” for certain employer contributions. Specifically, a vesting schedule may apply to profit sharing contributions or discretionary matching contributions in a 401k Plan or 403b Plan, and benefits under a Defined Benefit or Cash Balance Plan may be subject to vesting. “Safe harbor contributions” cannot be subject to a vesting schedule and are required by law to be 100% vested immediately.

Employers have the discretion to decide what vesting schedule to use. The most common vesting schedules are:

  • 3 year “cliff” vesting, which provides no vesting until completion of 3 Plan Years of employment with (typically) at least 1,000 hours paid per year, at which time 100% vesting occurs, or
  • 6 year “graded” vesting, which provides no vesting until completion of 2 Plan Years of employment with at least 1,000 hours paid per year when 20% vesting occurs, with an additional 20% vesting for each subsequent Plan Year with 1,000 hours, until 100% vesting occurs at 6 years.

As TPA, we review and update the vesting status for the Plan’s covered employees.

When a terminated employee takes a distribution and they have funds that are not vested in their Plan Account, a “forfeiture” occurs. In recent years, a point of emphasis for the IRS has been when and how the forfeiture balance is used. On a few occasions since the mid-2010s, the IRS announced required changes to Plan Document language that helped clear up the IRS’ position about how forfeitures may be used, making it clear that forfeitures can be used to pay proper Plan expenses, allocated to Plan participants as an additional employer contribution, and/or used to help fund/offset the cost of any employer contributions (including safe harbor contributions).

In 2023, the IRS finally proposed regulations making it clear when forfeiture balances must be used – forfeitures created in a Plan Year must be used no later than the end of the next Plan Year.

ACSI, during the annual compliance process, provides advice to clients to ensure that the Plan’s forfeiture balance is being used timely and properly.

For 401k and 403 Plans which make employer contributions on a per-payroll basis, it is important to have an operational process to timely exhaust forfeitures to avoid a worst-case scenario where forfeitures are not used by the end of the next Plan Year and need to be allocated to Plan participants as “additional” contributions at the last minute to stay compliant.

Recently, there have been a number of court cases alleging that the Plan’s fiduciaries breached their duties to Plan participants because of the way that forfeitures were used. While most of the cases appear to be the work of a couple aggressive law firms, the IRS and others are laser focused on forfeitures right now and the lesson should not be ignored: be sure your Plan is properly and timely using forfeitures.

To learn more about vesting schedules and the use of Plan forfeitures for your Plan, please reach out to those at ACSI who you contact about Plan matters.