Plan Forfeitures May Be Used To Satisfy 401(k) Safe Harbor Requirements Under IRS Proposed Regulation
- Feb 7, 2017
The IRS released proposed reliance regulations on January 17 that, if implemented, will make it easier for companies sponsoring 401(k) plans to meet the requirements for nondiscrimination for both employee salary deferral contributions under Internal Revenue Code (“IRC”) section 401(k) and employer matching contributions under IRC section 401(m).
Note: At the time of this writing, President Trump had issued a directive to all federal agencies to freeze all pending regulations. While not yet clear, the directive may at least temporarily stop the implementation of the proposed regulation although the IRS stated that plans sponsors may rely on the regulation as of its publication date – January 18, 2017.
Under current rules, if a 401(k) plan fails the applicable annual nondiscrimination testing for either or both the employee salary deferral contributions (“ADP test”) or the employer matching contributions (“ACP test”), one of the options for correcting the failure is for the plan sponsor to make a qualified nonelective contribution (“QNEC”) to pass the ADP test or a qualified matching contribution (“QMAC”) to pass the ACP test.
In order to be used to satisfy the ADP or ACP tests, the QNEC and QMAC contributions must conform to certain nonforfeitability and distribution requirements under the IRC and regulations. Specifically, they must be nonforfeitable when contributed to the plan [emphasis added] and may not be included in the determination of the maximum amount of a hardship distribution to a participant (unless contributed to the plan before December 31, 1988 and specifically allowed in the plan document). These requirements precluded plan sponsors from using amounts forfeited by plan participants that left the employer prior to being fully vested in employer matching or profit sharing contributions as QNECs or QMACs because the amounts did not meet these requirements at the time they were contributed to the plan. Consequently, plan sponsors would be required to contribute additional funds to the plan in order to satisfy the ADP and ACP testing.
The proposed regulation amends the definitions of QNECs and QMACs. Under the proposed regulations, a plan sponsor’s QNEC and QMAC contributions will be considered to satisfy the nonforfeitability and distributions requirements if they meet these requirements at the time they are allocated to a participant’s account [emphasis added] rather than when they were contributed to the plan. This will allow amounts being held as forfeitures in the plan to be used to satisfy failed ADP and/or ACP tests, which was not possible under the old rules.
The proposed regulations will alleviate the need for plan sponsors to contribute additional funds to the plan and adds some flexibility for managing the amounts the plan sponsor chooses to contribute to the plan with respect to any given plan year.
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Peter Alwardt is a Partner and the National Tax Leader of Employee Benefit Plans, specializing in employee benefits, tax and ERISA issues for domestic and international clients. He is a member of the American Institute of Certified Public Accountants and NY State Society of CPAs.
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