Forfeitures in Retirement Plans

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Recent developments highlight the need to address forfeiture and unallocated accounts in defined contribution retirement plans, such as 401(k) plans. Key issues include:

  • The IRS has set a deadline for using plan forfeitures.
  • Legal challenges are emerging regarding the discretion to use forfeitures for employer contributions.
  • Some providers are incorrectly mixing forfeitures with other unallocated funds.

New Deadline for Forfeitures

Defined contribution plans must now utilize forfeitures within 12 months after the end of the plan year in which they occurred. This applies to plan years starting on or after January 1, 2024.

Example: If an employee forfeits $1,000 on November 2, 2024, the plan must use this amount by December 31, 2025.

Grace Period for Existing Forfeitures

Plans must also use any pre-2024 forfeitures within 12 months after the end of the first plan year starting January 1, 2024, typically by December 31, 2025.

Example: If a plan accumulated $26,000 in forfeitures between 2021 and 2023, it has until December 31, 2025, to utilize those funds.

Legal Challenges and Compliance

Some participants are suing major employers, alleging misuse of forfeitures to reduce employer contributions instead of paying plan expenses. Courts have issued conflicting rulings on this matter, emphasizing the need for plan sponsors to review their language regarding forfeitures.

Key Takeaways for Plan Sponsors

  1. Review Plan Documents: Ensure they allow current forfeiture practices; amend if necessary.
  2. Adhere to IRS Deadlines: Align your plan’s deadlines with the new IRS regulations.
  3. Utilize the Grace Period: Amend your plan to allow the use of accumulated forfeitures during the grace period.
  4. Maintain Account Separation: Keep forfeiture accounts distinct from other unallocated accounts.
  5. Document Usage: Keep thorough records of forfeitures and their applications.

By taking these steps, plan sponsors can ensure compliance and avoid potential issues related to forfeitures and unallocated accounts.

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