The U.S. Department of the Treasury has recently proposed new regulations that clarify when and for what purposes defined contribution plans — such as 401(k) plans — may use forfeitures. These regulations are proposed to apply for plan years beginning on or after January 1, 2024, but employers may rely on them now.
Although these new regulations largely follow prior guidance from the Treasury and Internal Revenue Service, many employers have struggled with the concept of forfeitures, and how to ensure their plans are compliant. Before these newly proposed regulations, guidance on forfeitures was spread out between the Internal Revenue Code (the “Tax Code”), regulations, IRS revenue rulings, IRS Q&As and even IRS newsletters. For example, a 2010 IRS newsletter noted that some administrators placed forfeited accounts in a plan suspense account and allowed them to accumulate over several years, a practice not allowed under the Tax Code. Thankfully, having to distill all these sources and their guidance is no longer necessary in the wake of the new regulations.
Permitted Uses and Deadline
Under the proposed regulations, defined contribution plans may use forfeitures to do any of the following:
- Pay plan administrative expenses.
- Reduce employer contributions under the plan.
- Increase benefits in other participants’ accounts in accordance with plan terms.
The proposed regulations also require that defined contribution plans use all forfeitures no later than 12 months after the end of the plan year in which the forfeitures occurred. The deadline is intended to alleviate administrative burdens that could arise in using or allocating forfeitures that are incurred late in the plan year.
Transition Rule for 12-Month Deadline
The regulations provide a transition rule related to the 12-month deadline: Any forfeitures incurred during a plan year beginning prior to January 1, 2024, will be treated as having been incurred in the first plan year that begins on or after January 1, 2024. This means “old” forfeitures must be used no later than the end of that first plan year.
The New Regulations and You
What do these new regulations mean for you and your defined contribution plan? First, review your plan document. Under the new regulations, the plan document may specify any or all the permissible uses of plan forfeitures. From a compliance perspective, however, the plan should include more than one permissible use to avoid an operational failure should the forfeitures in a given year exceed the amount that may be used for that one purpose.
Second, check with your recordkeeper to ensure that they (1) are properly following the language in the plan document regarding allocating and using forfeitures and (2) have a process to ensure that all forfeitures are allocated and used prior to the end of the new 12‑month deadline.
For questions about how these new regulations may impact your retirement plan, or questions surrounding other employee benefit matters, please contact Lisa Zimmer, Bran Cross or your Warner employee benefits attorney.