In February 2023, the Internal Revenue Service ("IRS") issued proposed regulations to update the rules regarding the use of forfeitures by qualified retirement plans. Plan sponsors must ensure that plan forfeitures are used appropriately to avoid any operational failures and to comply with their fiduciary duties. The proposed regulations apply for plan years beginning on or after January 1, 2024, and provide a compliance transition period.

Defined Contribution Plans (i.e., 401(k), 401(a), 403(b), 457(b), profit-sharing, including governmental plans)

The proposed regulations state that a defined contribution plan must state that plan forfeitures will be used for one or more of the following purposes:

1. To pay plan administrative expenses;
2. To reduce employer contributions under the plan (including restoration of inadvertent benefit overpayments and conditionally forfeited participant accounts); or
3. To increase benefits in other participants' accounts in accordance with plan terms.

The proposed regulations also state that a plan must provide that forfeitures will be used by no later than 12 months after the close of the plan year in which the forfeitures are incurred. For example, forfeitures incurred during the 2024 plan year must be used by the last day of the 2025 plan year. This is more generous than prior guidance, which provided that no forfeitures should remain unallocated beyond the end of the plan year in which they occurred. This timing rule confirms that forfeitures cannot be rolled over year-to-year indefinitely.

In recognition that the timing rule is a change for plans, the proposed regulations provide a transition period for plan sponsors. Any forfeitures incurred in a plan year beginning before January 1, 2024, are treated as if they occurred in the first plan year that begins on or after January 1, 2024. Therefore, for a calendar year plan, the forfeitures incurred before 2024 must be used no later than December 31, 2025.

Plan sponsors have flexibility in specifying the use of forfeitures, but they should review plan terms related to forfeitures to ensure that operation is consistent with plan terms. For example, if a plan states that forfeitures can only be used to pay plan administrative expenses, but the plan sponsor has been using them to reduce employer contributions, there has been an operational failure under the plan. Similarly, if a plan states that forfeitures can only be used to pay plan administrative expenses, but forfeitures exceed plan administrative expenses and, therefore, are not timely used, there has been an operational failure under the plan. To avoid this, plan sponsors should ensure that the plan documents provide sufficient flexibility in using forfeitures. For example, the plan document could state that forfeitures will be used to reduce administrative expenses and to the extent that the forfeitures exceed annual plan expenses, then the remaining forfeitures will be used to reduce employer contributions, if any, or allocated to plan participants. At the same time, employers should be cognizant of a number of recent lawsuits alleging that the use of forfeitures to offset future employer contributions rather than to pay administrative expenses otherwise borne by participants is an exercise of a plan sponsor’s discretion that constitutes a breach of fiduciary duty under ERISA. Accordingly, plan sponsors, particularly those with ERISA-covered plans, could consider eliminating discretion in the use of forfeitures in the plan document to reduce litigation risk.

Defined Benefit Plans (Not governmental Defined Benefit Plans)

The proposed regulations amend Treasury Regulations §1.401-7 to be in line with the minimum funding requirements for defined benefit plans under Code Sections 412, 430, 431, and 433. The proposed regulations would revise § 1.401-7(a) to eliminate the use of forfeitures by defined benefit plans to reduce employer contributions, as this conflicts with the minimum funding requirements. Instead, the proposed regulations allow defined benefit plans to use forfeitures to fulfill the minimum funding requirements. Anticipated forfeitures will be factored in based on reasonable assumptions when determining the present value of plan liabilities according to the plan's funding method. This will enable plans to account for the difference between actual forfeitures and expected forfeitures when calculating the plan's minimum funding requirement for future years. The minimum funding requirements under Code Sections 412, 430, 431, and 433 do not apply to governmental plans.

Next Steps

To prepare for these changes, plan sponsors should take the following next steps:

• Consider any necessary plan design and/or operational changes to address the proposed regulations;
• Take advantage of the transition relief to use up old forfeiture account balances;
• Consult with the plan administrator and recordkeeper to confirm any required administrative updates; and
• Consult with benefits counsel to discuss any questions regarding implementation and required plan amendments.

For more information about how these proposed regulations may affect your qualified retirement plan(s), please contact your Ice Miller Workplace Solutions lawyer with whom you regularly work.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.