May 16th, 2017
A plan participant who leaves employment before becoming fully vested in his or her employer contributions will generally forfeit any non-vested amounts. For example, if Participant A is 60% vested when she leaves employment, the remaining 40% of her account balance will be forfeited and placed into the plan’s forfeiture account at the time of the forfeiture event. When amounts are placed in the forfeiture account, there are restrictions relating to their use and timing, as discussed below.
Use of Forfeitures
First and foremost, forfeitures must be used in accordance with the terms of the plan document. If authorized by the plan, permissible uses include offsetting future employer contributions, paying reasonable plan expenses, restoring previously forfeited participant accounts, and providing additional contributions to participants. Plan forfeitures cannot be used to fund employee deferrals. In addition, the IRS has historically interpreted the regulations to require Qualified Nonelective Employer Contributions (“QNECs”) or Qualified Matching Contributions (“QMACs”) to satisfy the applicable nonforfeitability and distribution requirements at the time the amounts are originally contributed to the plan. This interpretation resulted in plan sponsors being prohibited from using accrued forfeitures to fund safe harbor contributions or corrective contributions. However, recently proposed regulations amend the definition of QNECs and QMACs to permit employer contributions to qualify as QNECs or QMACs as long as the contributions satisfy the applicable nonforfeitability and distribution requirements at the time they are allocated to participants’ accounts. Because plan sponsors may rely on these proposed regulations immediately, they may now use accrued forfeitures to fund safe harbor contributions or QNECs and QMACs (assuming it is permitted in the plan document).
When reviewing the use of forfeitures, you should check the plan document to see if there is a required ordering of permitted forfeiture uses; if there is, the ordering provision must be strictly followed. For example, if the plan document requires forfeitures to be used to offset employer contributions prior to making any end of year forfeiture allocations, you should ensure that the forfeitures have been used to offset employer contributions first.
Timing of Forfeitures
Two questions apply when considering the timing of forfeitures. First, at what point should a terminated employee’s non-vested account balance be forfeited? Second, how long does the plan have to use those forfeitures? Guidance for these questions is provided in the Internal Revenue Code and is generally outlined in the plan document. If there is not clear guidance in the plan document, it could lead to issues in plan administration, which could result in operational failures that may be identified during a subsequent plan examination. A terminated employee’s non-vested account balance may be forfeited on the earlier of the date on which the employee receives a complete distribution of his/her vested account balance or incurs five consecutive one-year breaks in service. Once forfeited, these amounts generally must be used no later than the end of the plan year in which the forfeitures occurred. Thus, plan sponsors cannot allow forfeitures to accrue over the course of several plan years without being allocated or used to pay eligible plan expenses.
An operational failure will result if forfeitures are not used timely or if they are not used as directed in the plan document. The correction methodology for this type of failure is to reallocate forfeitures to participants who should have received them had the forfeitures been allocated on time or as directed. This may result in additional costs of the plan sponsor. For example, the forfeitures may no longer be available to reallocate. In that case, the plan sponsor would need to make affected participants whole, either through a corrective contribution to the plan or by use of current forfeitures (which then could not be utilized to offset other expenses or costs).
If you have any questions, please contact our dedicated qualified plan team.
 Revenue Ruling 84-156
 Reg. §1.401(k)-1(a)(3)(iii)(C); See also the Listing of Required Modifications and Information Package (LRM) [10-2011]
 FR Doc. 2017-00876 Filed 1-17-17
 Rev. Rul. 80-155; See also Tr. Reg. §1.401-7(a)