Forfeitures in a qualified retirement plan refer to the non-vested portion of employer contributions relinquished by employees when they leave a company before meeting the vesting requirements. These forfeited funds are retained within the plan itself rather than being returned to the employer directly or distributed to the departing employees. The use of forfeitures within a plan is governed by the plan’s specific provisions, and the Internal Revenue Service ( IRS ) has clear guidelines for how they can be used.
Forfeitures must be used in one or more of the following ways ( consult your plan document for your plan’s provisions for usage ):
- To pay plan administrative expenses.
- To reduce employer contributions.
- To be allocated to participants’ accounts.
Reducing future employer contributions: One common use of forfeitures is to offset the employer’s future contributions. For example, if an employer is required to make a matching contribution or a profit-sharing contribution, the forfeitures can be applied to satisfy a portion or all of this obligation.
Paying plan expenses: Another permissible use of forfeitures is to cover the administrative expenses of the plan. These costs can include services such as record-keeping, legal fees, accounting, and auditing services. The ability to pay plan expenses with forfeitures benefits both the employer and the plan participants, as it reduces the overall costs associated with running the plan, which might otherwise be borne by participants or the employer.
Reallocation to participants: Plans may also permit unused forfeitures to be reallocated to participants according to the provisions of the plan document.
New IRS rules on forfeiture usage
New IRS rules require that forfeitures be used no later than 12 months after the close of the plan year in which they were incurred.
- For example, a participant is 80% vested on a distribution of $1,000 in employer contributions on August 31, 2024. They forfeit $200, which becomes unallocated plan assets. These $200 forfeitures must be used in accordance with IRS rules and the plan document by December 31, 2025.
Transition relief: Forfeitures incurred in any plan year that began before January 1, 2024, may be deemed incurred during the first plan year beginning on or after January 1, 2024.
- Suppose that a plan is on a calendar year and had forfeitures incurred prior to January 1, 2024. Under the transition relief, these forfeitures may be deemed incurred during 2024, which means they must be used prior to December 31, 2025.
Steps you can take
- Evaluate whether you have an outstanding forfeiture balance in your plan and determine when forfeitures were incurred.
- Review your plan’s provisions around the use of forfeitures.
- Determine when forfeitures must be used by and make a plan to use all forfeitures subject to the transition relief by December 31, 2025.
- Ensure that your plan has designed and implemented internal controls to ensure that forfeitures will be used on a timely basis in accordance with your plan document for all periods following the transition relief.
