The Internal Revenue Service (IRS) recently issued proposed regulations that would require forfeitures in defined contribution plans—i.e., unvested benefits forfeited by terminating defined contribution plan participants—to be used to offset employer contributions or pay reasonable plan administrative expenses, or otherwise be allocated to participants, by the end of the year following the year of forfeiture.
Plan sponsors will have a generous transition period to use forfeitures incurred but not used before 2024 for these purposes. The proposed regulations also clarify the use of forfeitures in defined benefit plans. The proposed regulations are effective for plan years beginning on or after January 1, 2024, but they may be relied on immediately.
Defined Contribution Plans
Under the proposed regulations, a defined contribution plan must state that forfeitures of unvested benefits be used no later than 12 months after the close of the plan year in which the forfeitures were incurred (subject to a transition rule, discussed below). This is more generous than the IRS’s previous position, set forth in informal guidance issued in 2010, that “[n]o forfeitures in a suspense account should remain unallocated beyond the end of the plan year in which they occurred.”
The new timeline is intended to “alleviate administrative burdens that may arise in using or allocating forfeitures if forfeitures are incurred late in a plan year.” The IRS warned that failure to use plan forfeitures in accordance with the plan’s terms and these proposed regulations would constitute an operational failure requiring correction under the IRS’s Employee Plans Compliance Resolution System (EPCRS) to maintain the plan’s qualified status.
Defined Benefit Plans
The proposed regulations eliminate a provision in the 1963 forfeiture regulations that directed pension plan sponsors to use forfeitures as soon as possible to reduce employer contributions. This provision conflicted with minimum funding rules under ERISA and the Internal Revenue Code, enacted a decade later, that instead required the use of reasonable actuarial assumptions to determine the effect of expected forfeitures on plan liabilities.
However, the proposed regulations maintain the existing regulatory provisions that require a defined benefit plan to state that forfeitures cannot be used to increase the benefits of other participants (stemming from the requirement that a pension plan must provide “definitely determinable benefits”).
IRS Request for Comments
Plan sponsors and recordkeepers still have time to weigh in on these proposed regulations, as the IRS requested comments by May 30, 2023 on all aspects of the proposed regulations. The IRS specifically requested comments on (1) whether the rules for the use of forfeitures in defined benefit and defined contribution plans could be further simplified to reduce administrative costs and burdens, and (2) whether any issues could arise concerning other unallocated amounts (e.g., suspense accounts from excess contributions or service provider credits) with respect to qualified retirement plans, and, if so, whether guidance should be provided addressing those issues.
Next Steps
If the proposed regulations are finalized in their current form, plan sponsors will need to ensure that their qualified retirement plans include the required language regarding forfeitures and that such language is followed operationally.
In preparation for these rules becoming final, plan sponsors and their recordkeepers should catalog any plan forfeiture and suspense accounts, review the policies currently in place for the use of such funds, and make a plan to spend down any account balances for the permitted purposes as soon as possible.