Forfeiture Rule Changes


Earlier this year, the IRS issued proposed regulations to allow plans to use forfeited balances to fund fully vested sources of contributions. These rule changes, if finalized, will provide employers increased flexibility to use forfeited balances to offset required safe harbor and corrective contributions to 401(k) plans.

The rules prior to these proposed changes restricted the use of forfeited amounts to the sources from which they were generated. This created situations where there was no way to use accumulated funds to offset required contributions. For example:

Plan XYZ is a 401(k) plan with a 3% non-elective safe harbor contribution feature. The sponsor also makes profit-sharing contributions in some years (which are subject to a vesting schedule) but has decided not to make such contributions in the current year. Four terminated employees received distributions during the plan year, and three of them had less than six years of service, which resulted in the forfeiture of their non-vested balances. Under the existing rules, the employer cannot use the forfeited amounts to offset any fully vested contribution source, such as the safe harbor contribution. Because there is no profit-sharing contribution for the year, the forfeiture balance would have to be allocated to eligible participants or used to pay plan expenses.

The proposed regulations allow forfeitures to be used to fund automatically vested contribution sources, including safe harbor non-elective and matching contributions, qualified non-elective contributions (QNECs) and qualified matching contributions (QMACs). The IRS has confirmed that using the forfeiture to fund these sources will not compromise their function to correct plan non-discrimination issues, so long as they are characterized as non-forfeitable when utilized.

Proposed regulations are effective for taxable years following the year they are finalized. However, these proposed regulations can be relied on for plan years after 2016. While plan sponsors can apply the rule currently, an amendment will be required to most pre-approved documents to remove the plan restrictions on the use of forfeitures.

For questions or more information, please contact Richard Green at rgreen@windes.com or 844.4WINDES (844.494.6337).