Forfeitures can be cumbersome for plan administrators as they try to find the best way to apply them in their 401(k) retirement plans. Some plan administrators aren’t sure of what a forfeiture is, or even if they are using them in accordance with Treasury regulations. Forfeitures arise when a participant terminates a plan before they meet the full vesting requirements of the plan. Understanding forfeitures and knowing when and how to use them has never been clear. The good news is that the U.S. Treasury Department has issued proposed regulations that may provide more guidance on the timing and use of forfeitures.
Existing Regulations for Defined Contribution and Defined Benefit Plans
Currently, defined contribution plans do not have set regulations regarding forfeitures. The main sources of guidance are revenue rulings, various legislative history, and IRS newsletters. The most helpful guidance comes from a 2010 IRS newsletter mentioning that plan documents should specifically state when and how a plan will use and allocate forfeitures. Additionally, forfeitures are not allowed to be put into suspense accounts to accumulate earnings over time as some plan administrators are currently doing.
Forfeitures that are in suspense accounts should be used up by the end of the plan year in which they occurred, which coincides with other guidance stating forfeitures may be used to reduce plan expenses and employer contributions but cannot be carried over to any subsequent plan years.
Treasury Regulation 1.401-7(a) provides the best guidance regarding defined benefit plans, which states that forfeitures are not allowed to be used to increase the benefits of other participants in the plan. Similar to defined contribution plans, these forfeitures must be used as soon as feasible to reduce employer contributions to the plan. Current regulations also state that defined benefit plans may anticipate the effect these forfeitures will have on the plan when determining costs under the plan.
Proposed Regulations for Defined Contribution and Defined Benefit Plans
The U.S. Treasury Department has issued proposed regulations that should provide plan administrators with a clearer understanding of the timing and use of forfeitures. Keep in mind that if these proposed regulations are finalized, you may have to amend your plan for the changes. Below are the proposed regulations for defined contribution plans and defined benefit plans.
Defined Contribution Plans: The plan must state that forfeitures must be used within 12 months of the plan year they were incurred. These forfeitures may be used for one or more of the following:
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- To pay plan expenses
- To reduce employer contributions
- To increase benefits of other eligible participant accounts in accordance with the plan
Defined Benefit Plans: The plan must state that forfeitures cannot be used to increase the benefits of other participant accounts, but the effect of forfeitures may be anticipated when determining the costs of the plan for minimum funding purposes.
These proposed regulations, if finalized, would be effective for plan years beginning on and after January 1, 2024. There is a transition rule allowing forfeitures incurred in any plan year that begins before January 1, 2024, to be used by the end of the first plan year beginning on or after January 1, 2024. You may want to consider talking with your financial advisor and third-party administrator to make sure your retirement plan will comply with these new regulations once they take effect.
If you have any questions regarding CECL or would like to discuss how the standard will impact your organization, please reach out to your Hawkins Ash representative.
