By Rachel Gonner, CPA, Business Assurance and Advisory Services Supervisor | Employee Benefit Plan Audit (ERISA) Team
Overview of 401(k), 403(b), and Profit Sharing Plan Forfeitures
For many retirement plans, January 1st is the start of a new plan year and a great time to review the plan, including the balance in the forfeiture account. A large or growing forfeiture balance at year-end may indicate that forfeitures have not been properly applied—a defect that could result in disqualification of the plan’s tax-exempt status and/or penalties by the Internal Revenue Service (IRS).
What is a Retirement Plan forfeiture?
Defined contribution plans typically include a separate account to accumulate forfeitures. These represent funds which may not be attributable to any specific participant and for which use is dictated by the plan documents. Forfeitures may result from a variety of sources such as the following:
- Non-vested employer contributions of former employees, which are added to the forfeiture balance according to plan documents, typically once the former employee:
- receives a full distribution of the balance, or
- incurs five consecutive one-year breaks in service
- Non-discrimination testing failures
- Contributions for lost participants and uncashed checks
Tip: Good recordkeeping over forfeiture sources is important as the use of forfeitures from certain sources may be restricted.
When must Retirement Plan forfeitures be used?
The IRS requires that forfeitures not be accumulated over several years. Depending on plan documents, generally the deadline of using forfeitures is the end of the:
- Plan year in which they occur, or
- The following plan year, in limited situations
Failure to follow the deadline prescribed by plan documents may be considered a qualification defect by the IRS, which can result in excise taxes and/or contributions becoming taxable for the years during which forfeitures weren’t properly used.
How can Retirement plan forfeitures be used?
Forfeitures must be used in manner favorable to participants. Plan documents will specify the permitted uses of forfeitures, but often forfeitures can be used to:
- Reduce or offset employer matching and non-elective contributions, as well as the following effective July 2018:
- Safe Harbor Contributions
- Qualified Non-elective Contribution (“QNECs”)
- Qualified Matching Contributions (“QMACs”)
- Add or reallocate additional contributions to participant accounts
- Pay plan administrative expenses
- Restore forfeited contributions of certain rehired employees
Tip: If reallocating additional contributions to participants will result in the creation of many new participant accounts in the plan, declaring a matching contribution in the amount of the forfeiture account may be preferable.
Correcting and Preventing Carryover Balances in Employee Benefit PLans
If forfeitures were not used in accordance with plan documents, the employer may be able to correct the error and avoid plan disqualification by using the IRS Self Correction or Voluntary Correction Programs through the IRS Employee Plans Compliance Resolution System (EPCRS). The IRS may require that the employer retroactively apply contributions to participants accounts along with earnings, which can result in former participants receiving additional contributions. Employers should consult legal counsel to assess options for correcting prior errors and potential legal issues.
As a good practice to avoid future errors, employers should:
- Ensure provisions of the plan documents are unambiguous, compliant with regulations, and are understood by responsible personnel, and
- Establish procedures to monitor forfeiture accounts to ensure funds are used timely and in accordance with plan documents
Tip: Third-Party Administrators or Recordkeepers may be able to assist with applying forfeitures or by providing regular reminders or status updates of the forfeitures balance.
Taking steps now to ensure that forfeitures are used timely and as specified by the plan documents can be a simple process that can help employers avoid the risk of losing the plan’s tax qualification and save considerable administrative burden and expense in the future.
- “Improper Forfeiture Suspense Accounts.” Retirement News for Employers. Spring 2010.
- “Issue Snapshot – Plan Forfeitures Used for Qualified Nonelective and Qualified Matching Contribution.” gov
The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.