IRS Proposes Rules on Permitted Uses of Forfeitures in Qualified Retirement Plans

Practical Law Legal Update w-038-6333 (Approx. 4 pages)

IRS Proposes Rules on Permitted Uses of Forfeitures in Qualified Retirement Plans

by Practical Law Employee Benefits & Executive Compensation

Background

Plan sponsors can generally use forfeitures of ERISA plan benefits to:

Pay permissible, reasonable plan expenses.
Reduce future employer contributions.
Reallocate the forfeiture among the accounts of active plan participants.
Restore previously forfeited participant accounts.

Forfeitures must generally be used or allocated in the plan year in which the forfeiture occurred. Before 2010, many plans included forfeiture provisions that permitted forfeitures in suspense accounts to carry over to subsequent plan years. However, the IRS's position is that forfeitures must be used or allocated in the plan year in which the forfeiture occurred, reasoning that:

Revenue Ruling 80-155 precludes a plan from carrying over plan forfeitures to subsequent plan years because it requires defined contribution plans to allocate funds to participants' accounts according to a formula defined in the plan (and all monies in a defined contribution plan must be allocated annually to plan participants).
Treasury Regulation 1.401-7(a) provides that forfeitures must be used as soon as possible to reduce employer contributions.

However, the IRS has also stated that depending on the plan terms or the facts and circumstances, "it may be appropriate to take non-current-year forfeitures and use them as employer contributions for the current plan year."

This has led to some confusion among practitioners and plan sponsors regarding the timing of when forfeitures must be used.

(See IRS: Retirement News for Employers (Spring 2010).)

Proposed Regulations

The proposed regulations revise Treasury Regulation Section 1.401-7(b) to:

Provide that all forfeitures must be used "no later than 12 months following the close of the plan year in which the forfeitures were incurred under plan terms."
Provide a transition rule for defined contribution plans that provides that any forfeitures that occur in a plan year that begins before January 1, 2024, would be treated as having occurred in the first plan year that begins on or after January 1, 2024. The 12-month period would begin at the end of that plan year.
Clarify that all defined contribution plans may use forfeitures to:
- pay the plan's administrative expenses;
- reduce future employer contributions; and
- increase benefits in other participants' accounts.

The proposed regulations also amend Treasury Regulation Section 1.401-7(a) to remove the requirement that forfeitures be used as soon as possible to reduce employer contributions which conflicts with the minimum funding rules for defined benefit plans (requiring employers to use actuarial assumptions to estimate the effect of forfeitures on plan liabilities).

Comments on the proposed regulations are due by May 30, 2023.

Applicability Date

The proposed regulations would apply to plan years beginning on or after January 1, 2024, but plans may rely on the proposed regulations before that date.

Practical Implications

Previously, there has been some confusion for practitioners and plan sponsors around the timing of when forfeitures must be used. The proposed regulations should provide some welcome guidance regarding when forfeitures must be used. Practitioners and plan sponsors should review their plan terms and consider amending their forfeiture provisions to comply with the proposed regulations (including the timing of when forfeitures must be used and the permitted uses of forfeitures), as applicable.

IRS Proposes Rules on Permitted Uses of Forfeitures in Qualified Retirement Plans | Practical Law