Proposed regulations on using forfeitures in retirement plans
TAX ALERT | March 07, 2023
Authored by RSM US LLP
Executive summary: Use of forfeitures in retirement plans
The proposed regulations REG-122286-18, released Feb. 24, provide guidelines for plan administrators to use amounts that are forfeited back to a retirement plan and create separate rules for defined benefit plans and defined contribution plans.
When an employee leaves employment prior to completing a retirement plan’s minimum years of service for vesting, the employer-provided amounts allocated for that employee are forfeited back to the plan and must remain in the plan trust.
The IRS and Treasury published proposed regulations on Feb. 24, 2023 that create separate rules, for both defined contribution and defined benefit plans, for using amounts forfeited back to the retirement plan.
Use and timing of forfeitures in defined contributions plans
The proposed regulations clarify that forfeitures arising in any defined contribution plan (including money purchase pension plans) may be used for one or more of the following purposes:
- to pay plan administrative expenses,
- to reduce employer contributions under the plan, or
- this includes the restoration of inadvertent benefit overpayments and the restoration of conditionally forfeited participant accounts that might otherwise require additional employer contributions
- to increase benefits in other participants’ accounts in accordance with plan terms.
The proposed regulations require that plan administrators use forfeitures no later than 12 months after the close of the plan year in which the forfeitures are incurred. This deadline is intended to alleviate administrative burdens that may arise in using or allocating forfeitures when forfeitures are incurred late in a plan year. Although nothing in the proposed regulations would preclude a plan document from specifying only one use for forfeitures, the plan may fail operationally if forfeitures in a given year exceed the amount that may be used for that one purpose.
A transition rule is provided in the proposed regulations. Forfeitures incurred during any plan year that begins before Jan. 1, 2024, are treated as having been incurred in the first plan year that begins on or after Jan. 1, 2024. The IRS likely included this transition rule knowing that many plans have accumulated large amounts in their forfeiture suspense account and may need time to address how to use those amounts.
Use and timing of forfeitures in defined benefit plans
The rules relating to the use of forfeitures in defined benefit plans are updated in the proposed regulations to provide new minimum funding requirements. Currently, under reg. section 1.401-7(a), forfeitures under pension plans need to be used as soon as possible to reduce employer contributions. The minimum funding requirements of sections 412, 430, 431, and 433 do not allow the use of forfeitures to reduce required employer contributions to a defined benefit plan in the manner contemplated by existing reg. section 1.401-7. Rather, reasonable actuarial assumptions are used to determine the effect of expected forfeitures on the present value of plan liabilities under the plan’s funding method. Differences between actual forfeitures and expected forfeitures will increase or decrease the plan’s minimum funding requirement for future years pursuant to the plan’s funding method. The proposed regulations would update reg. section 1.407-1(a) to become consistent with the new minimum funding requirements.
The proposed regulations are to apply for plan years beginning on or after Jan. 1, 2024, but plan administrators can rely on them starting immediately. The Treasury has specifically asked for comments on the following, (1) whether the rules for the use of forfeitures in defined benefit and defined contribution plans can be further simplified to reduce administrative costs and burdens and (2) whether any issues arise concerning other unallocated amounts (in addition to forfeitures) with respect to qualified retirement plans, and, if issues do arise, whether guidance should be provided addressing those issues. Comments to the proposed regulations are due by May 30, 2023.
In the defined contribution plan context, these proposed regulations bring important clarity to when a plan must allocate or otherwise use its forfeiture balance. This has been an area of inconsistent practice amongst plan sponsors, with some plans accumulating unnecessarily large balances in the forfeiture suspense account. However, existing IRS guidance specifying when to allocate or use up those balances consisted only of some general statements found in an article titled Fixing Common Plan Mistakes: Improper Forfeiture Suspense Accounts which was in the Spring 2010 issue of the IRS’s Retirement News for Plan Sponsors.
Employers should be aware of their forfeiture suspense account balances and develop a plan for using such amounts.
This article was written by Bill O’Malley, Chloe Webb and originally appeared on 2023-02-28.
2022 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
MBE CPAs is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.
For more information on how the MBE CPAs can assist you, please call us at (608) 356-7733.