The IRS has recently proposed changes to the rules of forfeitures in both defined contribution plans and defined benefit plans and will be applied to plan years beginning on or after January 1, 2024.
Forfeitures occur when an employee terminates prior to completing the plan’s service requirement for vesting. Any employer contributions that have been allocated to a participant’s account would then be forfeited back to the plan based on the vesting schedule in the plan document.
One of the proposed changes for a defined contribution plan relates to the timing of the use of forfeitures which would require the forfeiture balance to be used no later than 12 months after the end of the plan year in which the forfeiture is incurred. It has been noted that some plans have large forfeiture balances that have been accruing over the years. To alleviate some of the stress of using the entire balance, the IRS proposed regulations will allow for a longer period to use these forfeitures during the first year of the proposed change. This transition rule in the proposed regulations states that any forfeitures incurred before January 1, 2024, will be considered as incurred in the first plan year that commences on or after January 1, 2024, allowing for additional time for these accumulated forfeitures to be used.
In many prototypical defined contribution plans, forfeitures can be used for the purpose of:
- Paying plan administrative expenses.
- Reducing employer contributions.
- Increasing benefits in a participant account in accordance with plan terms.
With this proposed change, the IRS recommends the use of forfeitures for more than one permissible purpose. If a plan chooses to restrict the use to only one purpose, then they cannot exceed the amount that may be used for that one purpose in a given year. If they exceed this limit, the plan could have an operational failure. A plan can choose to use forfeitures for additional purposes, but the plan must be amended for this. The plan sponsor should review the plan document verifying its use of forfeitures and determine if it is following the terms of the document.
Proposed changes for a defined benefit plan relate to the use of forfeitures and a conflict that exists in the current rules regarding minimum funding requirements. The 1963 forfeiture regulations required plan sponsors to use forfeitures as soon as possible to reduce employer contributions, however, this provision conflicted with the minimum funding requirements of ERISA and the IRS which require the use of actuarial assumptions to determine the present value of plan liabilities when considering the expected forfeiture balances of a plan. The differences between the actual forfeitures and the expected forfeitures used in an actuarial calculation could change the funding requirement of a plan in the current and future periods. The proposed regulations eliminated the requirement for forfeitures to be used as soon as possible therefore eliminating the conflict with the minimum funding requirements. However, the proposed regulations would still require a plan to state that forfeitures cannot be used to increase the benefits of other participants.
Once the proposed regulations on forfeitures are finalized, the new regulations will be effective for plan years beginning on or after January 1, 2024. The IRS allowed for comments on the proposed regulations through the period of May 30, 2023.
Author: Alyson Giambrone, MBA | [email protected]
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For more information about the impacts of the proposed forfeiture rules, please contact a member of Withum’s Employee Benefit Plan Services Team.
