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401(k) Plan Forfeitures – The Forgotten Funds

Dec 11, 2020

Forfeitures are plan assets generally derived from non-vested employer contributions that are forfeited from a participant’s account when that participant terminates employment and is not fully vested.

The plan document may specify the timing of the forfeiture, however, generally it has been the earlier of the complete pay out of the vested balance or when the participant has incurred a five-year break in service.

Note: Participant deferrals, pre-tax or after-tax deferrals, Qualified Non Elective contributions (QNEC), and Qualified Matching Contributions (QMAC) are always 100% vested and non-forfeitable.

How can you use forfeitures?

Plan sponsors should have proper procedures in place to utilize the forfeitures occurring annually in accordance with their plan documents. As per relevant regulations determined by Internal Revenue Service and the Internal Revenue Code (“IRC”), forfeitures can be utilized to:

  • Reduce employer contributions.
  • Pay plan expenses.
  • Allocate to other participants in the plan.
  • Restore previously forfeited accounts.

As we look toward year-end, it is important for plan sponsors to consider the forfeitures that may exist and how best to utilize them.

In this tumultuous year, forfeitures may prove beneficial to helping companies continue to provide the plan benefits to which their participants have grown accustomed, such as employer match and discretionary employer contributions. Alternately, these funds can help ease the burden of expenses incurred by benefit plans as employers use them to pay audit fees or third-party administrator expenses. Finally, in lieu of a holiday bonus, employers may consider reallocating forfeitures to boost the accounts of others in the plan.

What is the risk of not utilizing forfeitures?

The IRC does not allow plan administrators to place forfeited amounts into a plan suspense account, allowing them to accumulate over several years.  Doing so may affect the plan’s tax qualified status. Forfeitures must be used or allocated in the plan year incurred. 

Revenue Ruling 80-155 states that a defined contribution plan will not be qualified unless all funds are allocated to a participant's account in accordance with a definite formula defined in the plan. Essentially, the forfeiture account balance should be zero at least once during the year.

It is essential that plan sponsors and plan administrators understand the plan provisions, including how and when the forfeitures would occur and how and when to utilize them. Best practices include monitoring the forfeitures account activity on an ongoing basis, ensuring forfeitures are created and utilized in accordance with the terms of the plan, and making sure the forfeiture account balance is zero at least once during the year.

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