At Warner Norcross + Judd LLP, we understand that running an automotive supplier business involves more than just industry-specific issues. That's why we regularly provide important insights and tips on broader legal trends to help you navigate challenges and keep your business thriving.
Today, we highlight news from the employee benefits sector involving forfeitures and other unallocated accounts in defined contribution retirement plans, such as 401(k) plans.
Let’s first start with the definition of a “forfeiture.” When a partially vested participant terminates employment and takes a distribution of his or her vested balance, the amount left behind is called a forfeiture. Plan sponsors have some discretion in how they use forfeitures, but some restrictions apply.
A recent eAlert drafted by our Employee Benefits Practice Group highlighted recent issues regarding how retirement plans apply forfeitures and other unallocated accounts.
Here’s what you need to know:
- The Internal Revenue Service (IRS) has set timing deadlines for plan forfeiture use. Prior to recent proposed regulations from the IRS, the timing for when defined contribution plans must use forfeitures had been murky.
- Participants in retirement plans have brought legal challenges to plan sponsors exercising discretion to use forfeitures to reduce employer contributions.
- Some plan providers are improperly mixing forfeitures with other unallocated funds.
Key Takeaways for Plan Sponsors
To provide you with a concise overview of what employers need to know about this development, here are the key takeaways from our more robust eAlert:
- Review your plan document and ensure that:
- Your plan permits your current forfeiture practices and procedures. If not, you will need to make a plan correction.
- Your plan’s deadline for using forfeitures is not earlier or later than the new IRS forfeitures deadline. The deadline is no later than 12 months following the end of the plan year in which the forfeiture occurred. The new deadline takes effect for plan years beginning on or after Jan. 1, 2024. If the plan deadline is earlier than the IRS deadline, an amendment will provide you with more flexibility to use your forfeitures. If the plan deadline is later, an amendment is needed to comply with IRS requirements.
- Your plan allows you to use the IRS grace period, if needed. The proposed regulations provide a “grace period” for acclimating to the new deadline. Defined contribution plans must use all pre-2024 forfeitures no later than 12 months after the end of the first plan year beginning on or after Jan. 1, 2024. For most plans, this date is Dec. 31, 2025. You may need to amend your plan to permit the use of accumulated forfeitures during the grace period.
- Be aware that some plan participants are litigating the use of forfeitures to reduce employer contributions, despite the IRS having accepted this practice for decades both in plan documents and on review in audits. Fiduciaries and employer sponsors should monitor these cases as they progress and may want to take action regarding their plan language and use of forfeitures.
- Maintain your forfeiture account separate from other unallocated accounts, such as suspense account funds or ERISA spending account funds, to reduce employer contributions. If this is not possible, plan recordkeepers should maintain thorough records that distinguish the sources of funds in a single account.
- Keep sufficient records to show how and when you use forfeitures and other unallocated accounts.
- If your plan provides discretion to apply forfeitures to pay expenses or reduce employer contributions, consider whether an amendment would be appropriate. If in practice you are consistently applying forfeitures using the same method each year, then we recommend amending your plan to eliminate that discretion. If you are exercising that discretion from year to year, then we recommend you contact us to discuss whether an amendment would be appropriate in your circumstances.
For a more detailed review of the changes with forfeitures and other unallocated accounts, please read our recent employee benefits eAlert.
If you need assistance reviewing your plan documents, revising your administrative procedures or drafting a plan amendment, please contact Mary Jo Larson, Justin Stemple, Brandon Cross, your Warner attorney or a member of our Employee Benefits Practice Group.
