Most 401k plans include either employer match contributions or employer profit sharing contributions. These types of contributions may have a vesting schedule attached to them which is determined by the employer. A vesting schedule dictates how much of the employer contributions are owned by an employee based on their time with the company. This means each employee will vest, or own, a certain percentage of their account in the plan each year. Forfeitures typically happen when an employee leaves or is terminated and is not fully vested in their account balance. The non-vested portion of their account will become a 401k forfeitures and that money will remain in the plan when the participant distributes their funds.
In the document of most plans, it is required that the employer move unvested amounts to a specified forfeiture account. Most plans also require the employer to use the forfeited balances in the year incurred, and provisions may require that these balances be only used for the following:
- Administrative plan expenses
- Reduce future contributions made by the employer
- Allocate to active employees participating in the plan
- Restore previous forfeited participant accounts
It is important to use the forfeitures by the timeline dictated by the plan as this could result in disqualification of the plan’s tax status. Common mistakes employers make is that they allow these amounts to accumulate over the years. To avoid making that mistake plan administrators should review the plan document to ensure they are allocating the forfeited account balance in a timely matter. In addition, plans should be aware of the options available for the utilization of forfeitures. Many plans provide multiple options, and it is up to the plan administrators to determine the best use of the forfeiture.
Plan administrators should be knowledgeable about when 401k forfeitures happen, how to use them and when to use them. When the plan administrators evaluate how they are operating their plan it can save them costly plan corrections in the future.
Please contact your Henry+Horne advisor with any questions.