In its Spring 2010 issue of Retirement News for Employers, the IRS stressed the importance of timely allocating forfeitures within defined contribution plans. Also included was the recommended correction method for when a plan sponsor fails to allocate forfeitures to participants on time. This article will discuss the timeframe for allocating forfeitures and the appropriate corrections for when a failure occurs.
When non-vested money is forfeited and placed into a suspense account it is important that plan sponsors are aware of the timing requirements for the allocating of forfeitures. The Internal Revenue Code does not allow for forfeitures to accumulate for several years in a suspense account. Forfeitures should be used to pay plan expenses or as employer contributions in the plan year in which the forfeiture occurred. Allowing forfeitures to remain unallocated over future plan years would conflict with Rev. Rule. 80-155, which requires all funds in a defined contribution plan to be allocated to participant accounts in accordance with a defined contribution formula annually.
Plans that use forfeitures to pay expenses or reduce employer contributions should have plan language and administrative procedures in place to ensure the timely use of forfeitures in the year in which they occurred.
Following year exceptions
There are limited exceptions under which the forfeitures may be allocated by the end of the following year. Only under certain situations may forfeitures be held unallocated in a suspense account and used in the year following the year in which they occurred. Here are examples of the following year exception:
- The plan language states non-vested money will be forfeited as of the last day of the plan year. If a plan matched on a per payroll basis there is the possibility that all or most of the employer match would have already been made by the time the plan’s annual forfeiture process occurs.
- Forfeitures are used to reduce employer contributions, and the amount forfeited in a given year exceeds the total employer contribution for that year.
- If the allocation of forfeitures would result in §415 limits being exceeded the amount in excess of the §415 limit can be used in the following year
In all the above exceptions, the plan sponsor may not make additional employer contributions until all of the outstanding forfeitures from the prior year are allocated.
The proper correction for forfeitures that remain in a suspense account for too long is to reallocate the forfeiture to participants who would have been entitled to the contribution had it been exhausted in a timely manner. This includes allocating forfeitures to terminated participants that have received distributions from the plan.
This type of error is eligible for correction under the IRS’ Employee Plans Compliance Resolution System (EPCRS). Section 6 of Rev. Proc. 2008-50 details the availability for using the Self Correction Program (SCP) or the Voluntary Correction Program (VCP).