Many Plan Sponsors understand that plan design has a big impact on participation and savings rates in their retirement plan. However, many fail to correlate how the plan design can have a big impact for plan sponsors depending on the plan forfeiture provisions. If a 401k plan is designed to apply a vesting schedule to employer contributions, the plan may generate forfeitures money (forfeitures can be generated when an employee terminates employment and wasn’t 100% vested). How these forfeitures can be used varies depending upon how the plan is designed.
The IRS recently expanded the types of employer contributions that may be funded with forfeitures, making this an ideal time review your plan’s forfeiture provisions to ensure you are leveraging these plan assets appropriately.
The New Guidance- This year, the IRS proposed a change in the regulations that provides greater flexibility on how forfeiture dollars may be used. Historically, plan sponsors have been able to use forfeitures to offset employer contributions such as matching and profit sharing contributions, but have not been able to use forfeitures to fund a Safe Harbor 401(k) contributions, a Qualified Non-elective Contribution (QNEC) or Qualified Matching Contribution (QMAC). The proposed changes permit these types of employer contributions to be funded with forfeiture dollars. Plan sponsors may rely on the proposed regulations immediately. Since there was previous regulatory restriction on using forfeitures to fund safe harbor contributions, plan documents may have to be amended before plan sponsors can take advantage of this provision. You will need to check your plan provisions.
Who May Benefit from the New Rules- Plan sponsors that may benefit the most from the new rules are those who have struggled to pass their Annual Plan Discrimination Testing (The Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test.) These tests ensure that the highly compensated employees (HCEs) do not defer or receive matching contributions that are a disproportionately greater percentage of their compensation than the non-highly compensated employees (non-HCEs). Plans with low participation or savings rates often have trouble passing these tests each year. ( Also see ARE YOUR EMPLOYEES PREPARED FOR RETIREMENT? and 4 SIMPLE WAYS TO INCREASE 401K PARTICIPANT SAVINGS)
If a plan fails either the ADP or ACP test for a plan year, the plan sponsor must take steps to correct the failure, such as returning the “excesses” contributions to the HCEs or make a Qualified Non-Elective contribution to the non-HCEs. If a plan has accrued forfeitures for the year, these dollars may now be used to fund these contributions.
Sometimes Plan Sponsors who routinely fail the ADP and/or ACP tests choose to redesign their plan as a safe harbor 401(k) plan, making the plan exempt from ADP/ACP testing if the plan sponsor makes a minimum employer contribution and meets certain other requirements. (also see Is Safe Harbor the Solution to your Company's Retirement Plan?)
Under the new IRS rules, both types of employer contributions may now be funded with forfeiture dollars, but the plan document may need to be amended to allow for this use. Employer matching and non-elective contributions made under a safe harbor 401(k) plan formula must be 100% vested, so would not produce forfeitures, but other employer contributions such as profit sharing contributions made to the plan may be subject to a vesting schedule and could produce forfeitures.
Plan Design Tips for Forfeitures
The following are some steps you may want to take to include forfeitures in your plan design review.
- Review the plan document to understand how forfeitures may be used.
- Review the amount of forfeitures generated by the plan, how the forfeitures are being used, and whether the account is being used up each year.
- Review the business objectives for the 401k plan, such as reducing plan costs or increasing savings rates, and whether the plan’s current use of forfeitures helps achieve these objectives.
If you would like help in reviewing your unique circumstances, analyzing the options available, and would like best-practice recommendations, please contact me at email@example.com or at 800.307.0376.
1 Proposed Treasury Regulations – REG-131643-15 – Definitions of Qualified Matching Contributions and Qualified Non-elective Contributions, January 2017