As a plan sponsor, chances are that at some point throughout the course of business, the employee benefit plan that you manage has encountered plan forfeitures. Forfeitures typically result from the termination of service by an employee who was not fully vested in his or her employer contributions. The confusion related to forfeitures doesn’t revolve around how they came about, but more so how to handle them when they occur.
There are multiple options for the allocation of forfeitures per Internal Revenue Guidance (“IRS”) guidance, which include: they may be used to pay a portion of the plan’s administrative fees, provide additional contributions to participants (with the exception of safe harbor matches), or reduce the funds allocated to employer contributions. One common mistake that plan sponsors make is to post the funds to a suspense account, and let them build for multiple years without any utilization. The IRS and Department of Labor both recommend that forfeitures should be utilized in the year of generation or as soon as feasibly possible.
Some of the most common reasons that forfeitures are not properly allocated may be due to simple oversight, a plan sponsor may lack knowledge with IRS and DOL regulations, the assumption may be made that the TPA will handle it, or the plan document may not be clear in its guidance. The most important takeaway is to review the plan document in detail regarding forfeitures to ensure that the plan is utilizing forfeitures as allowed and within the appropriate timing, to ensure that there are no errors made. Improper plan and forfeiture management could potentially impact the tax status of the plan.
It is crucial to communicate with the TPA and plan auditors, if applicable, to fully understand plan guidance, and to periodically monitor forfeiture activity for a successful plan year.
By Sarah McFarland