Forfeitures in Qualified Plans – Proposed Reguations
By Charles C. Shulman, Esq.
2023 proposed regulations regarding forfeitures. In February 2023, the IRS issued proposed regulations with specific rules for forfeitures of defined benefit plans and for forfeitures of defined contribution plans. Prop. Treas. Reg. §1.401-7, 88 Fed. Reg. 12282 (Feb. 27, 2023). These regulations are proposed to apply for plan years beginning on or after January 1, 2024, once finalized, and they have not yet been finalized. But Prop. Treas. Reg. §1.401-7(d) and the Preamble provide that taxpayers may rely on these proposed regulations for periods preceding the effective date of the regulations.
Three options for forfeitures in defined contributions plans. The 2023 proposed regulations provide that for forfeitures under a qualified defined contribution plan, the plan must provide that forfeitures will be used for one or more of the following purposes: (i) to pay plan administrative expenses; (ii) to reduce employer contributions under the plan; or (iii) to increase benefits in other participants’ accounts (in a nondiscriminatory fashion) in accordance with plan terms. Prop. Treas. Reg. §1.401-7(b)(1).
12-month deadline to allocate forfeitures in defined contribution plans. The 2023 proposed regulations also provide that for defined contribution plans, the forfeitures must be used no later than 12 months following the close of the plan year in which the forfeitures were incurred under the plan, and this rule must be stated in the plan. Prop. Treas. Reg. §1.401-7(b)(2).[1] As stated in the Preamble, this deadline is intended to simplify administration by providing a single deadline for the use of forfeitures that applies for all types of defined contribution plans and to alleviate administrative burdens that may arise in using or allocating forfeitures if forfeitures are incurred late in a plan year. Forfeitures incurred during any plan year that begins before January 1, 2024, will be treated as having been incurred in the first plan year that begins on or after January 1, 2024. Prop. Treas. Reg. §1.401-7(c).
The Preamble gives an example that if there are $25,000 of forfeitures in a plan year, and the plan incurs only $10,000 in plan administrative expenses before the end of the 12-month period following the end of that plan year, there will be $15,000 of forfeitures that remain unused after the deadline established in these proposed regulations, and the plan would incur an operational qualification failure because forfeitures remain unused at the end of the 12-month period following the end of that plan year.
Forfeitures in defined benefit plans may not be used to increase benefits to any employees under the plan but are instead are utilized as an actuarial gain that reduces future required employer contributions . Code §401(a)(8) provides that a defined benefit plan will not be qualified unless the plan provides that forfeitures must not be applied to increase the benefits any employee would otherwise receive under the plan. The 2023 proposed regulations provide that for forfeitures in defined benefit plans the plan must provide that forfeitures may not be applied to increase the benefits any employee would otherwise receive under the plan, unless there is a plan termination or freeze of contributions the plan. Prop. Treas. Reg. §1.401-7(a). This rule is also in the original 1963 Treas. Reg. §1.401-7. [2]
The proposed 2023 regulations provide that forfeitures in defined benefit plans may be used to reduce future contributions. Prop. Treas. Reg. §1.401-7(a). However, in contrast to the original 1963 regulations that defined contribution plan forfeitures must be used as soon as possible to reduce the employer’s contributions under the plan, the proposed 2023 regulations have removed this requirement because reasonable actuarial assumptions under the Internal Revenue Code already account for the forfeitures as an actuarial gain that reduces future required employer contributions. Instead, the proposed regulations provide that for defined benefit plans, the effect of forfeitures may be anticipated in determining the costs under the reasonable actuarial assumptions set forth in IRC §§430(h)(1), 431(c)(3) 433(c)(3). Prop. Treas. Reg. §1.401-7(a). As noted above, taxpayers may rely on these proposed regulations for periods preceding the effective date of the regulations.
[1] Prior to the 2023 proposed regulations, there was no specific regulations regarding forfeitures in defined contribution plans. Rev. Rul. 80–155, 1980–1 CB 84, referenced below does discuss distribution of forfeitures with respect to distributions to participants and that plans should be valued at least annually. As noted in the Preamble, an IRS newsletter, Retirement News for Employers (Spring 2010) noted that although some defined contribution have forfeited amounts in a plan suspense account accumulating over several years, the Internal Revenue Code does not allow this practice, and it is advisable that no forfeitures in a suspense account should remain unallocated beyond the end of the plan year in which they occurred or the immediately succeeding plan year, and the treatment of the forfeitures should be described in the plan.
[2] The proposed regulations do not contemplate using forfeitures in defined benefit plans to offset plan expenses, because actuarial assumptions regarding future contributions already account for the forfeitures.
