IRS Offers New Rules on Deadline for Using Retirement Forfeitures

The Internal Revenue Service proposed new rules on Monday  formalizing the timing and use of forfeitures in qualified retirement plans by plan sponsors.

The proposal, which would affect participants in, beneficiaries of, administrators of, and sponsors of qualified retirement plans, according to information published in the Federal Register.

It would more clearly define how retirement plans should handle money forfeited by participants when they leave an employer before the end of a vesting schedule, when they die or when other factors result in funds going back to the plan sponsor. While the rule likely will not change how plan advisers and administrators are currently operating, it would make those processes clearer, says R. Randall Tracht, an attorney with Morgan Lewis specializing in retirement plans and the Employee Retirement Income Security Act.

“The IRS has long been of the view that the Internal Revenue Code’s tax-qualification rules and requirements generally do not permit defined contribution plans to carry over unused and unallocated forfeitures from year to year,” Tracht says. “The IRS regularly expressed this position in the course of retirement plan audits, but, until now, the IRS had not issued formal regulations setting forth their position.”

In its proposal, the IRS said some defined contribution plan administrators place forfeited funds into a “plan suspense account” in which the money is held before being put to use. The proposed regulations would “generally require” that plan administrators use forfeitures no later than 12 months after the close of the plan year in which the forfeitures happened.

The proposal also specifies the uses for defined contribution plan forfeitures, which are to pay reasonable plan administrative expenses, reduce employer contributions or increase benefits for plan participants.

“Plan sponsors will want to review their plan terms and check with the plan’s recordkeeper to consider whether any changes to the plan’s terms or recordkeeping processes may be desirable,” Tracht says.

The proposed rules are effective for plan years beginning on and after January 1, 2024, and include a transition rule that deems pre-2024 forfeitures to have been incurred in the first plan year beginning on or after January 1, 2024, according to Tracht. This will allow plans time to comply with the new rules.

The IRS said that the proposed regulations are “not expected to require changes to plan terms or plan operations, or otherwise have a significant impact on plans or plan sponsors.” It did say, however, that it is seeking comment from smaller plans and plan sponsors to discuss the “impacts these proposed regulations may have.”

The agency will take public comments online or by mail until May 30 and will set a date for a public hearing if requested.