The U.S. Treasury Department issued proposed regulations regarding the treatment of forfeited amounts in tax-qualified defined benefit and defined contribution retirement plans. The February 27, 2023 proposed regulations, if finalized, would require plans to be amended to specifically address new rules regarding the treatment of forfeited amounts.
Forfeitures generally arise when a participant has a severance from employment before completing the requirements for full vesting under the terms of the plan. Forfeited amounts generally can be used to pay reasonable plan administrative expenses, and if permitted in a defined contribution plan, they can reduce future employer contributions or be reallocated among other eligible participants. Forfeitures in a defined benefit pension plan cannot be used to increase the benefits of other participants.
The deadline for using plan forfeitures has never been clear. The best available guidance has been in the form of a 2010 newsletter issued by the IRS Tax Exempt and Government Entities Division, which indicates that forfeitures cannot be carried over to any subsequent year. That is a largely unworkable rule, especially when a forfeiture does not arise until late in the plan year.
The new proposed regulations provide some flexibility for plan administrators but also may require plans to be amended (assuming the proposed regulations are finalized in their current form). Under the proposed regulations:
- A defined benefit pension plan must provide that forfeitures may not be applied to increase the benefits of any other participants, but the effect of the forfeitures may be anticipated in determining the costs of the plan for minimum funding purposes.
- A defined contribution plan must provide that forfeitures must be used, no later than 12 months following the end of the plan year in which they are incurred, for one or more of the following purposes.
- To pay reasonable plan administrative expenses
- To reduce employer contributions to the plan (including to restore previously forfeited amounts where applicable)
- To increase benefits in other eligible participant accounts in accordance with plan terms
If finalized, the new proposed regulations would be effective for plan years beginning on and after January 1, 2024. Also, a transition rule would allow any forfeitures incurred in any plan year that begins prior to January 1, 2024 to be used by the end of the first plan year that begins on or after January 1, 2024.
Attorneys in Ballard Spahr’s Employee Benefits and Executive Compensation Group counsel employers and other plan sponsors on matters involving executive compensation, retirement plans, health and welfare plans, ERISA, the Internal Revenue Code, HIPAA, and a variety of other applicable laws.
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