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Audit & Assurance, Employee Benefit Services

Proposed IRS Regulations for 401(k) Forfeitures

At a Glance

On February 27, 2023, the Internal Revenue Service (IRS) issued a notice of proposed rulemaking regarding the use of forfeitures in qualified retirement plans. Under the new law, plan administrators may need to change how they use plan forfeitures. For example, they can use them to pay for administrative expenses or reallocate funds to benefit other plan participants.


What Are Forfeitures?

When a participant separates from service with the employer before being 100% vested in plan benefits, the nonvested portion of the benefit becomes a forfeiture based on the earlier of:

a) Distribution of the vested account balance, or

b) Incurring five consecutive breaks-in-service.

Former participants who terminate and receive a distribution of their vested account balance and are then subsequently rehired may have the right to repay this distribution. To do so, the repayment must be made within five years from the date of reemployment or, if earlier, before the employee incurred five consecutive breaks-in-service (measured from the date of distribution).


Next Step

Understanding these potential changes is essential for companies to ensure compliance with the new regulations and efficiently manage their benefit plans.


Summary of the Proposed IRS Changes

While many of the rules outlined in the IRS notice have been in place for many employee benefit plan administrators, the new proposal would codify them into federal law.

According to the proposal document, the IRS suggested regulatory clarifications regarding what can be done with forfeited funds in four major areas: paying administrative expenses, reducing employer contributions, increasing benefits in other participant accounts, and restoring previously forfeited amounts of rehired participants.

The proposed regulations also include a forfeiture usage deadline to simplify managing 401(k)s and other qualifying plans.


Payment of Administrative Expenses

Under the IRS’s proposed regulations, forfeitures could be used to cover the administrative fees and expenses associated with managing the retirement plan.

According to the Department of Labor, there are several common expenses to organizations when managing a qualified plan. These include:

  • Administrative fees. All plans involve daily expenses covering essential administrative services. Typical examples include recordkeeping, legal, accounting, trustee, or custodial fees.
  • Investment fees. The plan may incur investment management fees if it includes investment options. These fees are typically a percentage of the assets invested.
  • Service fees. Many plans include optional features that can incur additional fees and costs.

In light of the proposed IRS regulations, forfeitures present a solution for covering administrative fees and expenses. Using these funds to pay for these costs can help alleviate the financial burden on plan administrators and support more efficient cost management, benefiting plan participants and contributing to the overall success of the plan.


Reducing Employer Contributions

The IRS proposal would allow employers to use the forfeited funds and reduce their contributions to a particular employee’s plan in specific situations. Possible examples include an employee’s termination or failure to meet plan requirements.

The IRS proposal specifies that employer contribution reductions also include corrective measures for specific situations. For example, if a participant is accidentally overpaid benefits, forfeitures could be used to offset the excess amounts.


Increasing Other Participant Benefits

The proposed regulations on the use of forfeitures could positively impact other participant benefits. The regulations clarify that forfeitures gained in a defined contribution plan can be used to increase benefits in other participant accounts according to the plan terms, such as reallocating forfeited amounts to benefit eligible participants. An example would be if someone leaves the company and their account balance is forfeited, that money can be redistributed to benefit other employees who are still part of the plan.


Resorting Previously Forfeited Amounts Of Rehired Participants

The proposed regulations on the use of forfeitures could positively impact rehired participants. If a plan participant previously forfeited nonvested contributions due to employment termination and then gets re-employed by the same company, forfeitures could be reinstated without requiring additional contributions from the employer.


Proposed Forfeiture Usage Deadline

The IRS proposed regulations would implement a deadline for the usage of forfeited funds in plans and other defined contribution plans. According to the proposal, plan administrators must use forfeitures within 12 months after the close of the plan year in which forfeitures are incurred.

The forfeiture deadline has the following objectives:

  • Ensure prompt allocation and utilization of forfeited funds within the plan
  • Discourage holding forfeited funds indefinitely
  • Encourages timely distribution or redistribution to benefit other plan participants
  • Provide deadlines for all types of defined contribution plans, not just 401(k) plans


When Do These Changes Go into Effect?

The proposed changes concerning the use of forfeitures in retirement plans were expected to become effective for plan years beginning on and after January 1, 2024. In the meantime, plan sponsors should use these proposals as guidelines for managing and allocating forfeitures.


How to Ensure Compliance With IRS Forfeiture Rules

As a plan administrator, your team can take several actions to ensure compliance with new forfeiture rules. Consider the following tips when managing your plan:

  • Review plan documents. Carefully review the existing plan document to ensure it allows for the specified uses of forfeitures as outlined in the proposed regulations.
  • Develop a forfeiture utilization plan. Establish a clear and comprehensive plan for utilizing forfeitures promptly after they occur to meet the 12-month deadline.
  • Training and education. Conduct training sessions for relevant staff members to ensure they understand the new regulations and the importance of complying with the 12-month deadline. Educate employees about the impact of forfeitures on their benefits.
  • Review current forfeitures. Evaluate any forfeitures incurred before the 2024 plan year and ensure they are treated in accordance with the transition rule outlined in the proposed regulations.

Companies should work with a professional Employee Benefits Plan (EBP) Advisor like Windes to ensure compliance and understand how to implement these changes. An EBP Advisory Team can guide you through these proposed regulations and help with plan adjustments. Our team of experts can analyze your existing plan features, determine plan costs, and decide on the best distribution options for specific situations.


Get Expert EBP Management Advice

Managing your qualified retirement plan and other benefit plans is your fiduciary responsibility. Ensuring your company remains compliant with IRS and DOL rules and regulations can be challenging. The IRS and DOL regularly introduce proposals for new or updated regulations, making it crucial to be aware of new legislation and understand how it will affect your plan.

Our team of professionals can provide expert advice on plan design, management, and regulatory compliance. We will work with you to ensure your plans comply with the latest IRS rules and regulations while remaining aligned with your business objectives. Connect with us today.


Therese Cheevers
Therese Cheevers, APA, ERPA

Partner-in-Charge, Employee Benefit Services

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