Defined contribution plans provide that forfeited employer contributions will be held in a forfeiture suspense account to be used for one or more of the following purposes:
- To pay plan expenses,
- To reduce future employer contribution obligations to the plan, or
- To be reallocated among the accounts of active plan participants.
Many plan sponsors are not aware of changes to the IRS’s forfeiture allocation rules and fail to use forfeitures within the timeframes established in those rules.
Forfeiture Suspense Accounts
Defined contribution plans often provide that employer contributions, whether matching or nonelective, are subject to a vesting schedule. When a participant terminates employment prior to becoming fully vested in these contributions, the participant will forfeit the unvested portion of his account on a date specified in the plan. Most plans provide that these forfeited amounts are moved temporarily to a forfeiture suspense account.
When to Use Forfeitures
Prior to the issuance of its Spring 2010 issue of Retirement News for Employers, the IRS had not stressed the timeframe for using the assets in forfeiture suspense accounts. However, the 2010 IRS publication clearly explained that plan sponsors may not allow forfeiture suspense accounts to accumulate forfeited monies indefinitely and provided helpful guidance on how quickly the assets must be used for other purposes.
The IRS publication articulated the following general rules:
- No forfeitures may remain in a forfeiture suspense account beyond the end of the plan year in which the forfeiture occurs, and
- No forfeiture should be carried into a subsequent plan year.
Comment: This interpretation contradicts the provisions in many plans that permit forfeitures in suspense accounts to carry over to subsequent plan years.
Notwithstanding the emphasis that the IRS placed on draining the entire forfeiture suspense account at the end of each plan year, the 2010 IRS publication provides an exception for forfeitures that are used to reduce plan expenses or employer contributions. In those cases,
“… there should be plan language and administrative procedures to ensure that the current year forfeitures will be used up promptly in the year in which they occurred or in appropriate situations no later than the immediately succeeding plan year.” [Emphasis added.]
This exception is confirmed in the IRS Defined Contribution Listing of Required Modifications and Information Package (8-2005) for use with prototype plans.
Thus, plan sponsors are left wondering whether they must use forfeitures by the end of the current plan year or whether they have an additional 12 months. It appears that forfeitures that are to be reallocated to the accounts of active participants must be used by the end of the year in which the forfeitures arise, while forfeitures that are to be used for other purposes may reside in the suspense account for a longer period. However, there is no insight into what would constitute an “appropriate situation” for this purpose.
Must a plan that reallocates forfeitures physically complete the reallocation by the last day of the plan year? Or may it complete the reallocation “as of” that date in the same manner as it allocates employer contributions that are made after the end of the plan year? This question is of particular concern for plan sponsors whose plans state that forfeitures will occur on the final day of the plan year. In that situation, it would seem impossible to reallocate forfeited amounts without the benefit of reallocating “as of” that date.
One way of managing this confusing IRS guidance is for plans to provide that forfeitures will occur on a stated date during a subsequent plan year. With such a provision, a plan sponsor would have the remaining portion of that plan year to reallocate the forfeited amounts or use them for another permitted purpose.
Fixing Forfeiture Suspense Accounts with Accumulated Forfeitures
Plan sponsors that find that they have not exhausted the forfeiture suspense account in a timely manner should consider using the IRS’s Employee Plans Compliance Resolution System (EPCRS) to correct this problem. The correction may be eligible for the Self Correction Program (SCP), which requires no government filing and no government fee. In general, the SCP is available for problems that are fixed within two years following the close of the plan year in which they occur or for problems that may be classified as insignificant. If SCP is not available, the problem may be corrected under the Voluntary Correction Program.
In general, a failure to properly allocate or use forfeited amounts may be corrected by reallocating forfeitures in the plan’s forfeiture suspense account to plan participants who should have received them had the forfeitures been allocated on time. This includes revising prior year allocation reports and paying amounts due to terminated participants. Depending on the terms of the plan or the facts and circumstances of a particular situation, it may be appropriate to take the non-current year forfeitures and use them as employer contributions for the current plan year. Plan sponsors should apply the correction principles in Section 6 of EPCRS when making such a correction.
Plan Sponsor To-Do List
Sponsors of defined contribution plans should:
- Review plan documents to confirm how various types of forfeitures are to be used.
- Analyze how the assets in forfeiture accounts have been used in the past and whether the plan has complied with the rules described above.
- Determine whether any correction is required.
- If necessary, create a compliant procedure for the future.
- Modify plan documents to reflect the selected procedure.