Consider Your Options with Nonvested Participant Forfeitures

Employee benefit plans offer a combination of vested and nonvested assets. If an employee leaves their company before their matching 401(k) contributions have vested, then those amounts will be forfeited by the employee.

As a plan sponsor, you have four options regarding forfeited dollars:

  1. Purpose them to assist with plan expenditures.
  2. Use them to offset funds required for matching contributions for active participants.
  3. Reallocate them equally among active participants.
  4. Return forfeited funds to former plan participants who rejoin the plan.

Plan documents commonly state that forfeitures should first be used to offset employer contributions, with the balance being used to assist with plan expenses. It’s critical to follow what the plan documents state, as the documents will also disclose when the forfeitures are to be allocated.  The forfeitures are not allowed to accumulate indefinitely within the plan.  The IRS has demonstrated in recent audits that such practices are unacceptable.

What Does Your Plan Document Say?

The plan document should define what the policy is for forfeitures.  However, at times plan administrators don’t review their plan documents and consequently treat forfeitures inconsistently. Be sure that your administrative practice is in line with your plan document.

It’s possible that, when you started the plan, you gave little consideration to the forfeiture options and may have utilized a broad statement in regards to forfeitures.  You should reevaluate the language included in the plan document and decide if the policy is consistent with your existing philosophy and practical needs.

For example, if you are presently distributing forfeitures among active participants, but are looking for means to reduce plan expenses, you might amend your plan document to use forfeitures to offset plan fees.

How Do You Define Forfeiture?

An additional principal policy decision is defining the timing of the forfeiture. Commonly, it occurs immediately subsequent to a participant’s separation of service. Again, the plan document will disclose when the forfeiture will occur. The key is to administer the plan according to its terms per the policy. A violation of the terms could endanger the plan’s qualified status. However, the IRS’s correction program is available when errors transpire.

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