Proposed Rule: Use of Forfeitures

[RatherBeGolfing]

I haven't seen much talk about this...

Proposed rule published 2/27/2023.  It did not receive many comments (ERIC, ARA, ABA, and ABC among the few that submitted comments).

The proposed rule would establish a requirement to use forfeitures no later than 12 months following the close of the plan year in which the forfeitures were incurred.

There is also a transition period for forfeitures incurred during plan years beginning before 1/1/24.  These forfeitures will be treated as having been incurred in the first plan year that begins on or after 1/1/24, and have to be used no later than 12 months following the close of the PY.

Proposed applicability date of 1/1/24, no final rule yet, but plan sponsors can rely on the regulation now.

How are you handling this?  Fire drill to use up forfeitures from past years to get in compliance? Plan document/amendment issues?  Absent clarification, would you consider the use of forfeiture for the 2025 PY but allocated in 2026 as being used no later than 12 months following close of the PY?  Curious what other think.

[MoJo]

So, first, this is a "firm" statement from the IRS of what they have been saying for some time - so the way we are interpreting this is "they mean it this time" especially since they've given the transition period (amnesty) to fix (certain) past sins.  In other words, "fix it now, or if we catch you, you really going to get it this time ...."

A problem, in our opinion, does exist with respect to the plan documents.  Our document (prototype) has *always* said forfeitures must be used no later than the end of the year following the year in which incurred, and for those who have accumulated forfeitures (despite our constant nagging), we've advised them that a correction requires going year by year and reallocating forfeitures based on the year in which incurred.  NOTHING we read in the proposed reg grants "amnesty" from having to follow the provision of the plan - and we doubt the IRS will allow you to ignore the plan provision in order to take advantage of the transition rule.  We do have clients with individually designed plans, that don't say when forfeitures have to be used, so maybe they can take advantage of the transition rule.

For now, we're advising our clients that "the IRS really really means it this time, so when we've told you in the past you had to do this, we believe you have to do this, or else!"

I doubt many will pay attention, so we will be dealing with audit issues ultimately.....

[RatherBeGolfing]

Thanks MoJo!

[Peter Gulia]

MoJo and other BenefitsLink mavens, in your experience, are there any employers that use forfeitures “[t]o reduce employer contributions” by applying a forfeiture balance as a setoff to the employer’s obligation to pay over participants’ elective-deferral contributions?

[Paul I]

IRS Publication 7335 (Rev. 6-2021) notes

IV. Vesting
Line a. Section 401(k)(2)(C) of the Code requires that elective contributions and other contributions that may be treated as elective
contributions, as described in V. and VI. below, must be nonforfeitable when made to the plan. In order for a contribution to be nonforfeitable
each participant, regardless of age or service, must immediately be vested in his or her elective contributions.
401(k)(2)(C)
1.401(k)-1(c)

and 1.401(k)-1(c) says

(c) Nonforfeitability requirements

(1) General rule. A cash or deferred arrangement satisfies this paragraph (c) only if the amount attributable to an employee's elective contributions are immediately nonforfeitable, within the meaning of paragraph (c)(2) of this section, are disregarded for purposes of applying section 411(a)(2) to other contributions or benefits, and the contributions remain nonforfeitable even if the employee makes no additional elective contributions under a cash or deferred arrangement.

(2) Definition of immediately nonforfeitable. An amount is immediately nonforfeitable if it is immediately nonforfeitable within the meaning of section 411, and would be nonforfeitable under the plan regardless of the age and service of the employee or whether the employee is employed on a specific date. An amount that is subject to forfeitures or suspensions permitted by section 411(a)(3) does not satisfy the requirements of this paragraph (c).

This section factored into the change in the IRS position that allowed forfeitures to be used to fund QNECs and QMACs.  The IRS previously said forfeitures could not be used to fund QNECs and QMACs since these amounts had to be 100% vested and would not give rise to forfeitures.  Upon revisiting their logic, the IRS said forfeitures could be used to fund QNECs and QMACs because these contributions were employer contributions when made to the plan and QNECs and QMACs were not subject to a participant election as elective deferrals when made.

This is a subtlety but the interpretation allowing the use of forfeitures for QNECs and QMACs was welcomed in the community.

This new logic, though, is not applicable to using forfeitures to fund elective deferrals made at the election of a participant, i.e., reduce the amount of elective deferrals owed to the plan. 

Have employers done this?  Very likely because no one told them they couldn't.  Is it a failure to deposit deferrals timely?  Yes.  Could the forfeitures used in this manner be considered a pre-funding of elective deferrals?  Could be.

My take on all of this is if the employer asks if they can do this, just say no.  If an employer is doing this, they should stop (and try to clean up the mess). 

[Peter Gulia]

Thank you for the helpful information.

I’ve never worked on a situation that used forfeitures for anything beyond plan-administration expenses; you helped me indulge a curiosity.

[RatherBeGolfing]

Timely article that came out in ASPPA NET yesterday afternoon:

Flexibility on the Use of Forfeitures—Not so Fast!!

Lawsuit against Thermo Fisher.   Document states that forfeitures can be used for expenses and to reduce contributions.  Thermo Fisher opted use forfeitures to reduce contributions over a 6 year period, while also paying plan expenses from plan assets.  

Claims are breach of fiduciary duty and engaging in prohibited transactions.

Dimou v. Thermo Fisher Scientific, Inc., S.D. Cal. No. 3:23-cv-01732 (9/19/2023) 

[Belgarath]

Fascinating!

[Peter Gulia]

If Konstantina Dimou’s fact allegations (which Judge Todd Wallace Robinson must assume in evaluating whether the complaint states a claim on which the court could grant relief) support the complaint’s assertions, a fiduciary’s breach—and a prohibited transaction—was possible because a fiduciary had or exercised discretion about the order in which to use forfeitures.

Among several ways to remove a difficulty, a plan’s sponsor might write the plan’s governing documents to provide the administrator no discretion about how to use forfeitures, instead specifying an ordering within the three recognized ways to use forfeitures.

Considering RatherBeGolfing’s observations (above) about a proposed rule, one might consider now a plan amendment a plan’s sponsor might prefer to adopt before a final or interim rule’s applicability date.

[Paul I]

This case will be interesting.  Before Cycle 3 restatements, pre-approved plan included provisions where the plan specified the sequence in which forfeitures would be applied, with one sequence applicable to forfeitures of non-elective employer contributions and another sequence applicable to forfeitures of matching contributions.  For Cycle 3 pre-approved plans, the IRS approved language which pretty much said do what you want with the forfeitures as long as you use them before the end of the plan year following the plan year in which the forfeiture occurred (with some choices for doing so earlier).

Plans commonly chose to use NEC forfeitures first to reinstate any forfeitures for rehires under the plan provisions, then to pay plan expenses, and then to allocate to participants using the plan's allocation formula (with allocating over compensation as the next best choice).  Match forfeitures were required to offset the employer's match obligation which almost always depleted the match forfeitures.  If in this case the plan had such provisions, then there should have been no discretion how to use forfeitures, or there was a failure to follow plan provisions.

(Notably, a plan that allows for discretionary contributions provides an end-around to using forfeitures to offset the contribution.  The employer declares the amount of the discretionary contribution with an eye on the total amount of contributions and forfeitures that are allocated to participants.)

A plan document with the do-what-you-want provision essentially grants that discretion to a fiduciary as identified in the plan.  This case sets up a conflict between exercising discretion granted in the plan document against always choosing what is the optimal use of forfeitures for the benefit participants.

Charging plan-related administrative expenses to the plan has always been allowed and, where applied, has always had participants complaining about it.  The counter argument boils down to employers are not required to sponsor a plan or pay the plan's administrative expenses, so why should they if they don't want to?  With many states mandating some form of access to retirement plans and the federal government moving towards "encouraging" access, it may be possible that our future may include a mandate that the plan sponsor must bear at least some of the costs of plan administration (e.g., plan audit, retirement or RMD distributions, ...)

One thing this case will do is having plaintiff's attorneys searching for plans (likely by reading audit reports downloaded from 5500 filings) that use forfeitures to offset plan expenses.

We live in an interesting time with respect to retirement plans.

 

[Peter Gulia]

If a plan’s sponsor uses a set of IRS-preapproved documents in which the basic plan document provides the administrator discretion on how to use forfeitures and nothing in the adoption agreement for a user to specify an ordering, does the Revenue Procedure about “administrative” provisions a user may add or change without defeating reliance on the IRS opinion letter allow adding a provision ordering the use of forfeitures?

[Paul I]

I expect formulating administrative policy is allowed without impacting the ability to rely on the opinion letter. 

As an example, many pre-approved plans have a check box that asks "Are Loans permitted:  Yes/No".  The Adoption Agreement then has an appendix or addendum titled Loan Policy with all of the details like number of loans, interest rate, refinancing...

I would see a Forfeiture Policy statement to be analogous.