Forfeiture Restoration

[Brenda Wren]

When a participant "buys back" his forfeiture, do I establish an after-tax or pre-tax account for him? Assuming the answer depends upon the source of the money coming back to the plan, i.e. IRA rollover or personal funds, do I have any responsibility to verify the source? What if the source is both?

[Richard Anderson]

If the funds for repayment come from a conduit IRA there will be no basis and you would allocate the repayment to the appropiate pre-tax account (match, p.s.). If all or any part of the repayment comes from personal funds, the repayment amount that came from personal funds will be the participant's basis in that account. If your software will track basis in a pre-tax account, you should not have to set up an after-tax account.

[Alan Simpson]

What if the plan doesn't allow after-tax contributions?

[Richard Anderson]

The plan must accept repayments from after tax funds without regard to whether after tax contributions are allowed in the plan. The repayment is not considered an after-tax contribution, but is a repayment of a prior distribution. The participant then has basis in the pre-tax account.

If the plan allows after tax contributions, the repayment should still go to the pre-tax account that the forfeiture originated from. Otherwise, if the repayment is allocated to a pre-tax account, it would be 100% vested. The restoration payment made by the plan sponsor would then be subject to vesting. The participant ends up with a higher vested balance than he should have.

Example: Participant terminates with an account balnace of 1,000 in which he is 20% vested. He receives a distribution of 200 and forfeits 800. He is rehired and pays back the 200, which is put in a 100% vested after tax account. The employer restores the 800 in a pre-tax account with 80% vesting. The participant has an incorrect vested balance of 360, 200 in the after tax account and 160 in the pre tax account.

The participant's repayment and the plan sponsor's restoration of the forfeiture should go back to the pre-tax account that it originated from, but with basis if the participant repaid out of after tax funds.

[This message has been edited by Richard Anderson (edited 06-28-2000).]