Retirement Plan Forfeitures: New IRS Deadline Requirements
Published on by Joe Conover in Benefit Plan Audits
When an employee leaves your company before they’re fully vested in their 401(k) plan, those unvested funds become forfeitures. How you handle these forfeited amounts is critical, as improper management could put you at odds with the IRS.
The IRS recently proposed new regulations that clarify exactly what you can do with these forfeited amounts. While the rules bring welcome clarity, they also introduce a strict deadline that plan sponsors need to understand.
What’s changing with plan forfeitures
In February 2023, the IRS issued proposed regulations that provide much-needed clarity around retirement plan forfeitures. The rules confirm what many plan sponsors have been doing while adding important new requirements.
The proposed regulations require that plan documents clarify how forfeitures can be used which should include one or more of the following purposes:
- Pay plan administrative expenses, including audit fees
- Reduce your employer contributions
- Reallocate the funds to other participants’ accounts following a nondiscriminatory formula
The significant change is timing: you now have just 12 months after the end of the plan year to use those forfeitures. For example, for a calendar year plan, if forfeitures occur in 2024, they must be used no later than December 31, 2025. Missing that deadline results in an operational failure that could jeopardize your plan’s qualified status.
The 12-month rule: a new compliance requirement
This new deadline requires proactive management rather than reactive handling. The 12-month clock starts ticking at the end of the plan year when the forfeiture occurs, creating a firm timeline for action.
The IRS included a transition rule for forfeitures that occurred before 2024, treating them as if they happened in your first plan year beginning on or after January 1, 2024. This provides plan sponsors with an opportunity to address any accumulated forfeiture balances.
Plan sponsors should be cautious about limiting their options. If your plan document only allows forfeitures to be used for one purpose, such as administrative expenses, and you don’t have sufficient expenses to use all the forfeitures, unused amounts will remain after the deadline. This creates a compliance failure that could have been avoided with more flexible plan provisions.
Steps for compliance
Plan sponsors should take several proactive steps to ensure compliance with the new requirements. First, review your plan document to confirm it addresses all permissible uses of forfeitures and specifies the timeframe for using them. Consider allowing multiple uses for forfeitures to provide operational flexibility.
Second, evaluate any existing forfeiture balances. The IRS has consistently discouraged allowing forfeitures to accumulate in suspense accounts, and the new deadline makes prompt action even more critical.
Finally, establish clear procedures to track forfeitures and ensure they’re used within the required timeframe. This systematic approach helps prevent compliance issues and demonstrates good fiduciary governance.
Implementation timeline
The proposed regulations apply to plan years beginning on or after January 1, 2024, though plan sponsors may rely on them earlier if beneficial. This gives organizations time to review their current practices and make necessary adjustments.
While these regulations largely formalize existing best practices, the 12-month deadline introduces new urgency to forfeiture management that many plan sponsors have historically handled on a more casual basis.
The bottom line
Concerned about how these forfeiture regulations could affect your retirement plan operations? We’re here to help you stay compliant. Contact us today to schedule a free consultation with one of our employee benefit pros who can help you in creating a roadmap for forfeiture management and meeting the new deadline requirements. You may also be interested in exploring our earlier post on forfeiture litigation to see how these issues can evolve into legal challenges.
