Employee benefit plans provide a combination of vested and nonvested assets. When employees leave a company before their matching 401(k) contributions have vested, they forfeit those amounts.
As a plan sponsor, you have four choices regarding what to do with forfeited dollars:
- Use them to offset plan expenses.
- Tap them to offset amounts needed for matching contributions for active participants.
- Reallocate them evenly among active participants.
- Return forfeited funds to former plan participants who rejoin the plan.
Many plan documents provide that forfeitures are first used to offset employer contributions, with any remainder used to pay expenses. The document will also state when these forfeitures are allocated, so it’s important that you follow the plan document. You can’t let these amounts accumulate indefinitely. The IRS has shown in recent audits that it doesn’t tolerate that practice.
What does your plan document say?
Your plan document should describe your forfeiture policy. However, sometimes plan administrators don’t review their plan documents and thus handle forfeitures inconsistently. Be sure that your administrative practice is in keeping with your plan document.
It’s possible that, when you started the plan, you didn’t give much consideration to the forfeiture options. You may have used some boilerplate language. So when you check your document, think about whether it’s consistent with your current philosophy and practical needs.
For example, if you currently distribute forfeitures among active participants but are looking for ways to lower plan expenses, you might amend your plan document to use forfeitures to offset plan fees.
How do you define forfeiture?
Another important policy decision is defining the timing of forfeiture. Generally, it occurs immediately following a participant’s separation of service. Again, the plan document will state when the forfeiture will occur. The key is to administer the plan according to its terms. A violation of the terms may jeopardize the plan’s qualified status. However, the IRS’s correction program is available when errors occur.
BPM is one of the largest California-based accounting and consulting firms, ranking in the top 50 in the country. It has served the San Francisco Bay Area's emerging and mid-cap businesses, as well as high-net-worth individuals, since 1986. Our Employee Benefits team consists of professionals with extensive knowledge of ERISA guidelines and deep expertise performing employee benefit plan audits. We can help you craft a smooth-running plan that serves your employees while mitigating associated risk. For more information or for a free expert consultation, contact Jenise Gaskin at (925) 296-1016, Michelle Ausburn at (707) 524-6588 or visit us at bpmcpa.com/ebp.