On February 27, 2023, the Department of the Treasury (“Treasury”) and Internal Revenue Service (“IRS”) issued proposed regulations (the “Proposed Regulations”) relating to forfeitures in tax-qualified defined benefit and defined contribution plans. Forfeitures generally arise when a participant terminates employment before completing the required service for full vesting of employer contributions under the terms of the plan. The Proposed Regulations provide much needed guidance on the permissible uses of forfeitures, as well as the timing on when a plan must expend the forfeitures. The Proposed Regulations set forth separate rules for defined contribution plans and defined benefit plans due to the different legal requirements applicable to each of these types of plans.
Application to Defined Contribution Plans
The deadline for allocating plan forfeitures in defined contribution plans has never been clear. In an Employee Plans newsletter issued in Spring 2010, the IRS took the position that the Internal Revenue Code does not authorize forfeiture suspense accounts to hold unallocated monies beyond the year in which they arise, thereby requiring that all forfeitures be used or allocated in the plan year in which they were incurred. This proved to be a difficult deadline to meet, especially when a forfeiture arose late in the plan year.
The Proposed Regulations provide guidance as to when defined contribution plans must use plan forfeitures and the purposes for which plan forfeitures may be used. According to the Proposed Regulations, defined contribution plans must provide that:
The IRS indicated that this single deadline, applicable to all defined contribution plans, is intended to simplify administration and alleviate administrative burdens that could otherwise arise in using or allocating forfeitures incurred late in a plan year.
Application to Defined Benefit Plans
Under current law, defined benefit plans must provide that forfeitures cannot be applied to increase the benefits payable to other participants. In addition, current regulations require that defined benefit plans use the forfeitures as soon as possible to reduce the employer’s contributions under the plan.
The Proposed Regulations would eliminate the requirement in the current forfeiture regulations that forfeitures under defined benefit plans be used as soon as possible to reduce employer contributions, because it is inconsistent with the minimum funding requirements. However, the Proposed Regulations maintain the existing requirement that a defined benefit plan must provide that forfeitures cannot be used to increase participant benefits.
Effective Date and Transition Relief
If finalized, the Proposed Regulations would apply to plan years beginning on or after January 1, 2024.
The Proposed Regulations also include transition relief for defined contribution plans with large, long-accruing forfeiture suspense accounts. The transitional relief would allow a plan to treat forfeitures incurred during any plan year that begins before January 1, 2024, as having been incurred in the first plan year that begins on or after January 1, 2024. This could allow plans to use the amounts in the forfeiture suspense accounts by the end of the 2025 plan year.
The Proposed Regulations do not address situations where a plan sponsor cannot use the full amount of a forfeiture suspense account because it exceeds both the amount of plan expenses and would cause excess annual additions under Internal Revenue Code Section 415. As such, plan sponsors with large forfeiture accounts should not solely rely on the transitional relief if any such issues could be ameliorated by beginning to expend the forfeitures before January 1, 2024.
Request for Comment
The IRS has requested comments on the Proposed Regulations, specifically on (i) whether the rules for the use of forfeitures in qualified plans could be further simplified to reduce administrative costs and burdens, and (ii) whether any issues arise concerning other unallocated amounts (in addition to forfeitures), and whether guidance should be provided addressing any such issues.
The comment period ends on May 30, 2023.
The post IRS Proposes Regulations on Using Forfeitures in Qualified Retirement Plans appeared first on Employee Benefits.
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