In an article by Fidelity Investments, the issue of plan forfeitures and plan forfeiture accounts is addressed with regard to acceptable allocation and use of these proceeds as well as timing of these allocations. Both timing and acceptable use are critical pieces of information for the plan sponsor regarding plan forfeiture accounts.
Defined contribution plans like a 401(k) often provide employer contributions (employer match) to participants, whether matching or nonelective, that are subject to a vesting schedule. When a participant terminates employment prior to becoming fully vested in those contributions, the unvested portion is forfeited on a date specified by the plan. While this process is generally straightforward, a plan may encounter challenges in determining how and when to use those forfeited assets appropriately.
Most plans provide that these amounts move temporarily to a forfeiture suspense account. Forfeiture account assets are plan assets to be used for the benefit of the plan. The plan document generally will contain provisions dealing with how and when these assets will be used. Depending on those provisions, forfeitures could be used to pay a plan’s reasonable administrative expenses, reduce employer contributions, or provide an additional allocation to participants.
According to Tristar Pensions:
Forfeitures are allowed to be used to pay for certain administrative expenses incurred by the plan such as; auditing, accounting, or recordkeeping fees, or fees for annual administration and compliance services. The forfeiture funds can also be used to reduce certain employer contributions to the plan, or they can be reallocated back to the remaining eligible participants as an additional contribution. Ultimately, the terms of the plan document govern how the forfeitures are used and the deadline or the Plan Year for using them. Typically, these forfeitures should be used or allocated during the plan year in which the forfeiture occurred and should not be carried over into subsequent years. However, specific language in the plan document can allow for the forfeitures to be distributed the year following the year in which the forfeitures occur.
When non‐vested money is forfeited and placed into a suspense account, it is important to be aware of the timing requirements. The general rule is that assets in a plan’s forfeiture account should be used or allocated in the plan year incurred. The IRS stressed the timeframe for using these assets back in 2010.
A plan that does not annually allocate forfeiture amounts may jeopardize its qualified plan status. This common plan mistake may be corrected using the IRS’s Employee Plans Compliance Resolution System (EPCRS). Usually, this error can be corrected by allocating the forfeitures to all plan participants who should have received them had the forfeitures been allocated on time. If the plan was supposed to use forfeitures in another manner, other correction methods may be appropriate.
Fidelity and other industry advisors recommend regular monitoring of such accounts as a rule. Improper use of proceeds in such accounts as well as improper timing on allocations can carry significant penalties for plan sponsors, including loosing qualified plan status.
