On January 18, 2017, the IRS issued proposed regulations that expand the permitted uses of forfeitures in a 401(k) plan. Under the proposed rules, the definitions of “qualified nonelective contributions” (QNECs) and “qualified matching contributions” (QMACs) would be amended in a manner that would allow plan sponsors to use amounts held in a 401(k) plan’s forfeiture account to fund QNECs, QMACs and safe harbor 401(k) contributions – a change long-requested by commenters.
QNECs and QMACs, which are typically used by 401(k) plan sponsors to correct nondiscrimination testing failures or plan operational failures, must meet certain requirements under IRS rules. Specifically, QNECs and QMACs generally must be nonforfeitable (i.e., 100% vested) and subject to certain distribution restrictions (i.e., they are unavailable for hardship withdrawals and must not be distributed prior to death, disability, severance from employment, age 59-1/2, or plan termination). Because the IRS defines certain safe harbor nonelective and matching contributions by reference to the QNEC and QMAC terms, the IRS has informally indicated that safe harbor 401(k) contributions must also have all of the required characteristics of a QNEC or QMAC.
Prior to the issuance of these proposed regulations, the IRS had informally taken the position that the nonforfeitability and distribution requirements would need to be satisfied on the date QNECs or QMACs are first contributed to the plan. This position limited the ability of plan sponsors to use forfeitures to fund QNEC and QMAC contributions since forfeited amounts most often arise from employer contributions that are not fully vested at the time they are initially contributed to a plan.
Under the new proposed regulations, contributions will qualify as QNECs or QMACs as long as they meet the nonforfeitability and distribution requirements at the time such amounts are allocated to participants’ accounts. These proposed rules are a welcome change to the previous view espoused by the IRS and will provide 401(k) plan sponsors, especially plan sponsors of safe harbor 401(k) plans or those who rely on QNECs to correct failed nondiscrimination tests, more flexibility in determining how to use and allocate plan forfeiture accounts (subject to plan terms). The regulations are generally proposed to be effective for taxable years beginning on or after the date the regulations are finalized, but may be relied on immediately pending the issuance of final regulations. In addition, informally, the IRS has indicated that the position taken in the proposed regulations can be relied on retroactive to the issuance of the proposed regulations as well.
It’s worth noting that the new White House administration issued a memorandum on January 20, 2017 directing federal agencies to delay the effective date for at least 60 days of published regulations that had not yet taken effect as of the date of the memorandum, and to review such regulations for “questions of fact, law and policy.” While the directives in the memorandum may apply to the proposed regulations discussed herein, we still believe plan sponsors should be able to rely on the guidance provided in the proposed regulations.