The February 24, 2023, issuance by the IRS of proposed regulations on the use of forfeitures in qualified retirement plans provides some welcome clarity, regulatory house cleaning, and relief for plan sponsors. With a proposed effective date of January 1, 2024, these regulations should prompt plan sponsors to review their plan language and procedures for compliance and to consider plan amendments to take advantage of the new rules.
Defined Contribution (DC) Plans. The proposed regulations expand and amend the general regulation on forfeitures, Section 1.401-7, to clarify that forfeitures in defined contribution plans (e.g., 401(k) and profit-sharing plans) must be used or allocated under the terms of the plan no later than 12 months following the close of the plan year in which the forfeitures occurred. Under a transition rule, any forfeitures incurred before January 1, 2024, will be treated as if they were first forfeited in the first plan year beginning on or after January 1, 2024. The new regulation states that a DC plan may use forfeitures for one or more of these purposes:
- Payment of plan administrative expenses;
- To reduce employer contributions; and
- To increase benefits in other participants’ accounts under the plan’s terms.
These revised forfeiture rules would essentially formalize what in the past has been informal IRS guidance for DC plan forfeitures. That guidance, expressed in a 2010 IRS Retirement News for Employers, generally required that forfeitures be used no later than the year in which the forfeitures arose while vaguely allowing an additional year to use the forfeitures where the situation demanded it. Unclear regulatory and informal guidance has resulted in many plans carrying forward forfeitures that are even older than two years. The transition relief offered for pre-2024 incurred forfeitures is welcome, but many sponsors may need plan amendments and revised administrative procedures to use or allocate their “legacy forfeitures” in order to take advantage of it.
Defined Benefit (DB) Plans. For defined benefit pension plans, the proposed regulations correct an inconsistency or conflict in the Treasury Regulations. The current general regulation on the use of forfeitures requires that pension plan forfeitures be used as soon as possible to reduce the employer’s contributions under the plan, but may not be used to increase employee pension benefits. Further, it provides that a pension plan may “anticipate the effect of forfeitures in determining the costs under the plan.” By contrast, the current minimum funding standards for defined benefit plans under Internal Revenue Code Sections 430, 431, and 433 do not provide that forfeitures may directly offset required employer plan contributions; rather those Sections instead require the use of reasonable actuarial assumptions to determine the effect of expected forfeitures on plan liabilities. The new proposed regulation deletes the provision allowing a direct reduction of employer pension plan contributions by the amount of forfeitures. It now simply states that the effect of forfeitures may be anticipated in actuarially determining the costs under the plan under the Code’s defined benefit plan funding standards.
If you have any questions, the Jackson Lewis Employee Benefits Practice Group members are available to assist. Please contact a Jackson Lewis employee benefits team member or the Jackson Lewis attorney with whom you regularly work if you have questions or need assistance.