Vesting at Plan Termination

Does someone here have insight or experience into whether the IRS would require full vesting for participants who incurred 5-BIS but the unvested amounts were not forfeited?  i.e. the unvested amounts were eligible to be forfeited but were not actually forfeited.

Thank you for your thoughts!!

Wouldn't the IRS go after the sponsor for failure to deal with the forfeitures properly when they should have?   Gotta think they'd want THAT for the other participants' sakes, like if they are instructed to reallocate.

It might help to distinguish between when an amount becomes forfeit and when the amount is segregated from the participant’s individual account.

If the participant did not yet receive a distribution, might the plan’s administrator now segregate the forfeited amounts and credit those amounts to the forfeiture account?

Whether slowness in segregating forfeitures affects other participants might turn on the plan’s provisions, especially if nondiscretionary, about using forfeited amounts.

Imagine the documents governing the plan provide that the order is:

first, a forfeiture amount sets off the employer’s obligation to pay a nonelective or matching contribution;

next, a remaining forfeiture amount (if any) is used to pay plan-administration expenses (or to reimburse the employer for its advance on expenses the employer was not obligated to pay);

last, a remaining forfeiture amount (if any) is allocated to participants’ accounts.

For many plans, the use of forfeiture amounts regularly stops at step one. So, a delay in segregating a forfeiture might burden only the employer.

But I concur with Bri that a delay in segregating a forfeiture matters more if the amount would or might have been used for allocations to participants’ account.

This is not advice to anyone.

Agree with @Bri that if amounts were not forfeited from accounts when they were required to be under the terms of the plan then you have an operational defect(s). Then, if defect(s) #1 resulted in forfeited amounts not being applied timely pursuant to plan provisions then you have operational defect(s) #2. 

If those forfeitures were supposed to be allocated or reduce expenses, then participants would have been harmed.

If they were supposed to reduce future contributions, yes, maybe only the employer was impacted, but that also enabled them to contribute and deduct more. 

Regarding IRS thoughts - I would suspect they'd want the defects corrected in accordance with the plan's provisions and not fully vest amounts that should have been forfeited years ago.

Agree.  If the amounts were forfeited, they were forfeited... even though not moved to forfeitures.  

Agree with the responses that the operational failure should be corrected by forfeiting unvested funds for employees who incurred 5-BIS now.  This issue went on for 15-20 years so reallocating the forfeitures or paying expenses for the applicable years is likely an administrative nightmare.  Adding to the complexity, the employer does not want to file VCP so we are hesitant to recommend any creative solutions.  So I think they will have to bite the bullet and fix the operational failures.  Thank you everyone for the helpful thoughts!

A couple of additional issues, as I see it.

1) The IRS does not permit amounts to be held in suspense that are not authorized under the Code (like when there are 415 violations that are not allocable).  The Service issued a proposed regulation (Prop. Reg. 1.401-7) that requires that forfeitures be used within 12 months of the end of the plan year in which they arose.

2) If the plan provides for use of forfeitures to: (1) reduce contributions; (2) pay expenses; and (3) reallocate, and there was no use for 1 or 2, i think the participants are entitled to receive the reallocation.  So, I would go back to the affected years and allocate the forfeitures.

If you self-correct, be sure to check both the forfeiture correction rules (if any) under EPCRS [I think there are some, and it may make the allocation correction easier], and do a self-correction memo.

FWIW - I recently had this exact problem and posed it to our "experts" for a service we subscribe to.  The attorneys there said that if the accounts had not been forfeited timely it was too late to forfeit them once plan termination was underway.  Quoting "if it hasn't yet been reflected as a forfeiture on the books and records of the plan, I would say it is fully vested".  The plan termination date was 12/31/25 and the question was asked on 12/26/25.