Understanding the IRS’s Proposed Regulations on Forfeitures in Defined Contribution Plans

The Internal Revenue Service (IRS) issued proposed regulations, effective for defined contribution plan years beginning on or after January 1, 2024, clarifying the timing and usage of forfeitures.

What are forfeitures and how can they be used?

Plans that have a vesting schedule mean participants will not be entitled to all the employer’s contributions until they have been employed for a specified period of time set forth in the plan document. The amounts participants are not entitled to can be forfeited and placed into a separate forfeiture account. The proposed regulation states forfeitures arising in defined contribution plans generally may be used for one or more of the following purposes: to pay plan administrative expenses, to reduce employer contributions or to increase benefits in other participants’ accounts (i.e., reallocated among plan participants).

It’s important to understand that each plan is different, and the plan document should specifically list out how forfeitures can be used and the order in which they can be used for that plan. Some may have flexibility in how and the order in which forfeitures can be used (e.g., forfeitures are used to pay plan administrative expenses or reduce employer contributions at the employer’s discretion) while others are more specific in how and the order in which forfeitures can be used (e.g., forfeitures are first used to reduce administrative expenses then used to reduce employer contributions).

When do forfeitures need to be used by?

The proposed regulation states that forfeitures must be used no later than twelve months after the close of the plan year in which the forfeitures are incurred. The proposed regulations provide a transition rule in which forfeitures accumulated prior to January 1, 2024, will be treated as if they were first forfeited during the 2024 plan year, thereby plan sponsors have until the end of the 2025 plan year to use all forfeitures incurred during or before 2024 in accordance with the terms of their plan document.

Conclusion

Noncompliance can jeopardize the qualified tax status of the Plan. Therefore, this transition relief gives plan sponsors an opportunity to start with a clean slate and get into compliance moving forward. It is therefore crucial for plan sponsors to begin to utilize forfeitures in a timely manner and in accordance with their plan document. In addition, we advise plan sponsors to review their plan document for how forfeitures can be used and the order in which they can be used and if necessary, consider amending plan documents to ensure the plan avoids any operation failures.

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About the Author

Cori Pruner is a Manager in GreerWalker’s business assurance practice and serves clients across industries including employee benefit plans, motorsports, real estate, professional services, and manufacturing/distribution.

Her journey with GreerWalker began during her senior year at UNCC when she attended GreerWalker’s summer leadership conference. Since then, she has constantly demonstrated her leadership skills and commitment to the growth and success of the firm.

Cori’s significant experience with employee benefit plan audits distinguishes her in the field. She diligently assists clients with defined contribution plan research and projects, providing them with the insights they need to make informed decisions. Cori is also committed to leading process improvement efforts resulting in more efficient and effective audits which makes her an invaluable member of the GreerWalker team.