An IRS proposed regulation would clarify the use of forfeitures in qualified retirement plans. Defined contribution (DC) plans would have to use these funds within 12 months after the end of the plan year in which the forfeiture arose. A transition rule would apply to forfeitures arising before the regulation’s effective date. The regulation would also better reflect the way the defined benefit (DB) plan funding rules implicitly reflect forfeitures in determining minimum required contributions. The proposed rule would take effect for the 2024 plan year, but sponsors and plan administrators may rely on the proposal immediately. Comments are due May 30, 2023.

Forfeitures in DC plans

Forfeitures can arise under a DC plan that includes a vesting schedule for certain employer contributions (e.g., an employer match under a 401(k) plan) when a participant terminates employment before fully vesting in those contributions. Forfeitures can also arise under other circumstances — for example, 401(k) plans can correct annual contribution percentage (ACP) testing failures by forfeiting highly compensated employees’ matching contributions. The proposed regulation would set a formal deadline for DC plans to use these forfeitures and require sponsors to specify in their plan documents how and when forfeited amounts must be used.

Deadline for using forfeitures. Under current rules, DC plans generally must use forfeitures by the end of the plan year in which they arise, which can prove challenging for forfeitures incurred late in a plan year. (A 2010 IRS newsletter said forfeitures could be held over to the next plan year “in appropriate situations,” but didn’t explain what those situations might be.) The new proposal would extend the deadline for using or allocating forfeitures in DC plans (including money purchase plans), giving plan administrators an extra year to take action. The regulation would require sponsors to state this deadline in their DC plan documents.

This change is meant to simplify administration and “alleviate administrative burdens” associated with forfeitures that arise late in a plan year. At the same time, the proposal is intended to end some plan administrators’ practice of holding unallocated forfeitures in a plan suspense account for several years.

Permitted uses. The proposal would require plan documents to specify that forfeitures will be used for one or more of the following purposes:

• Paying plan administrative expenses
• Reducing employer contributions, including restoring inadvertent benefit overpayments and conditionally forfeited participant accounts
• Increasing benefits in other participants’ accounts in accordance with plan terms, including funding ACP/actual deferral percentage (ADP) corrective and safe harbor contributions (as permitted by 2018 final regulations)

In the proposed rule’s preamble, IRS cautions employers against specifying only one use for forfeitures in the plan document. Doing so could result in an operational failure if forfeitures exceed the amount needed for the specified purpose in a given year.

Transition rule. The proposal would apply for plan years starting in 2024, but a transition rule would permit treating unused forfeitures from earlier years as if they arose in the 2024 plan year. Therefore, plan administrators will have at least 12 months after the end of the 2024 plan year to use those amounts. Plans with significant forfeiture balances may want to talk with their ERISA counsel to ensure timely and appropriate allocation of these funds to avoid an operational failure.

Forfeitures in DB plans

ERISA’s DB plan minimum funding rules (replicated in the Internal Revenue Code) automatically reflect anticipated forfeitures in the calculation of the current year’s required contribution. Any difference between anticipated and actual forfeitures will be reflected in future contributions. However, the current forfeiture regulations — written more than a decade before ERISA’s enactment — require DB plans to use forfeitures to offset required employer contributions as soon as possible. The proposal would eliminate this outdated requirement and better conform the forfeiture rules to the funding rules, but this change would have no impact on DB plans’ actual practice.

Request for comments

IRS welcomes comments on all aspects of the proposal, but specifically invites input on the following:

• Whether the rules can be simplified to further reduce administrative costs and burdens
• Whether issues about other unallocated amounts in qualified retirement plans exist, and if so, whether IRS should provide guidance on those issues

Related resources

• Proposed regulations (Federal Register, Feb. 27, 2023)
• Retirement news for employers (IRS, spring 2010)