Key Takeaways
- 401(k) plan sponsors should use forfeitures within 12 months after the plan year they arise and follow Internal Revenue Service (IRS) guidance and plan terms.
- Regular monitoring and coordination with recordkeepers, third-party administrators and payroll teams can reduce 401(k) forfeiture compliance risk.
- Documenting timely, authorized use of 401(k) forfeitures and keeping balances near zero can strengthen plan governance and reduce audit findings.
401(k) forfeiture balances may be small, but the compliance risk they create can be significant. When forfeitures are not monitored and used in accordance with the plan document and applicable guidance, plan sponsors can face audit findings, operational failures and avoidable corrective action. A disciplined process for reviewing and applying forfeitures can help reduce that risk and strengthen overall plan governance.
What Are Forfeitures?
A forfeiture occurs when an employee leaves a company before becoming fully vested in the employer contribution portion of their retirement plan account. The unvested employer contributions are not paid to the participant; instead, they remain in the plan as forfeitures. Depending on the terms of the plan document, forfeited amounts may generally be used to reduce future employer contributions, pay eligible plan expenses or restore previously forfeited participant accounts when required.
Because forfeiture accounts can easily be overlooked, balances may accumulate over time if they are not monitored and used in accordance with the plan document. As regulators have increased their focus on the timely use and proper administration of forfeitures, unused balances have become a more common audit finding.
When Must Forfeitures Be Used?
Current IRS guidance generally requires plan sponsors to use forfeitures no later than 12 months after the end of the plan year in which they arise. Equally important, forfeitures must be used in accordance with the terms of the plan document. Regularly reviewing forfeiture balances can help prevent compliance issues, reduce the risk of audit findings and minimize the need for corrective action.
Best Practices for Plan Sponsors
The following best practices can help your organization maintain compliance and ensure forfeitures are administered in accordance with your plan document.
- Know your plan document. Understand the permitted uses of forfeitures and review your plan document to determine whether it specifies the order in which forfeitures must be applied. If the plan document establishes a required sequence, plan administrators should follow those provisions consistently.
- Monitor forfeiture balances regularly. Review forfeiture balances throughout the year rather than waiting until year-end. Regular monitoring helps ensure forfeitures are used within the required timeframe.
- Coordinate with your service providers. Work closely with your recordkeeper, third-party administrator and payroll team to ensure everyone understands how forfeitures should be administered under the plan document.
- Document your decisions. Maintain meeting minutes or other administrative records demonstrating that forfeitures were applied on a timely basis, properly calculated, authorized and in accordance with the plan document.
- Keep the balance at or near zero. Rather than allowing forfeitures to accumulate from year to year, use them on a timely basis in accordance with the plan document and applicable IRS guidance.
The Takeaway
Although forfeiture balances are often relatively small, improper administration can lead to operational compliance issues, audit findings and unnecessary corrective actions. By monitoring forfeiture balances regularly and administering them in accordance with both the plan document and current IRS guidance, plan sponsors can strengthen plan governance, reduce compliance risk and help ensure their retirement plan remains in compliance.
Contact Us
If you have questions about how forfeitures may affect your retirement plan, our Employee Benefit Plan Services team can help assess your plan’s forfeiture practices, identify potential compliance risks and provide guidance on proper administration.
Linda McLean, CPA
Partner
lmclean@pkfod.com
Danielle R. Arsenault, CPA
Director
darsenault@pkfod.com