By Debbie Herbert, CPA, Director at Blue & Co.

If your defined contribution plan has a vesting schedule for employer contributions, you may be familiar with the term ‘forfeitures.’ In such a plan, forfeitures are typically generated when an employee terminates employment and takes a distribution prior to being fully vested in the employer contribution; the unvested portion remains in the plan as a forfeited account balance.

The plan document (and the adoption agreement, if applicable) will specify the exact criteria for when a forfeiture occurs. (In a simple example, if a participant is 20 percent vested in their employer contribution at the time they take a qualifying distribution, the remaining 80 percent of the employer contribution balance in the participant’s account may now be classified as a forfeiture.)

As with other areas of plan administration, it is important for the plan to operate within the terms of its plan document, to maintain its tax-qualified status. Therefore, as a plan administrator, it is important to understand the balance of your plan’s forfeitures, as well as the provisions of the plan document that dictate how and when these forfeitures are to be used.

The plan document may indicate that forfeitures are to be used to pay plan administrative expenses and/or to reduce employer contributions, or it may specify that such balances are to be allocated to other plan participants. The plan document will also specify when these forfeitures are to be used or allocated, which is often by the end of the plan year following the date such forfeitures occurred. In 2023, the Department of Labor issued proposed regulations that emphasize this timeframe. While this guidance has not been finalized, forfeitures have increasingly become a hot topic in the regulatory environment.

Under the proposed regulations, it may be necessary for a plan to use any accumulated forfeited account balances within a shortened timeframe. Plan administrators should recognize that for some plans with a large balance of forfeitures, this may pose a challenge.

Plan administrators should consider communicating with individuals at the plan sponsor, including those responsible for paying plan administrative expenses and those responsible for determining and funding employer contributions, to ensure awareness of the amount of the forfeitures available for use, and the timeframe in which they need to be used. Likewise, plan administrators are encouraged to discuss with their service providers their planned use of forfeitures, to ensure they are remaining in compliance with the plan document and to ensure that there are no unintended effects on their annual compliance testing results.

For specific questions about how your plan may be impacted, please reach out to us!

Debbie Herbert

Senior Manager

Phone/fax: 812-405-1733

Email: dherbert@blueandco.com