Getting Familiar With Forfeitures

Angela Trefethen

When was the last time you thought about your retirement plan’s forfeiture funds? If it’s been a while, it’s a good time to get reacquainted.

In 2023, the Internal Revenue Service doubled down on decades-long forfeiture regulations for qualified retirement plans. Effective January 1, 2024, forfeitures must be used no later than 12 months after the close of the plan year in which they were incurred. As part of this notification, the IRS gave employers until the end of 2025 to address any past oversight in the timely use of aged forfeitures. 

What Are Forfeitures?

Forfeitures occur when an employee leaves a company before meeting the retirement plan’s vesting requirements to become fully vested. When employees are fully vested, they’re entitled to all the contributions the employer made to their retirement account. If only partially vested, non-vested amounts are generally released to a plan-level forfeiture account when a participant is terminated or when a terminated participant reaches a five-year break in service.

The IRS specifies that forfeiture funds cannot be held indefinitely in a forfeiture account. Employers must ensure forfeiture dollars are used within a specific time limit in accordance with IRS regulations and as provided for in plan documents.

How Can Forfeitures Be Used? 

Distributing forfeitures is a regulatory requirement. However, prompt reallocation can also benefit your plan and your participants.

Some examples of ways to use forfeiture funds:

• Apply the funds to plan expenses for services such as recordkeeping, auditing, and legal or accounting fees;
• Use the funds as an employer credit, applied to matches, profit-sharing or discretionary contributions; and
• Reallocate to current participant accounts.

What Happens When Forfeitures Are Not Reallocated in a Timely Manner?

Forfeitures that have reached their expiration date and are not used to pay for plan expenses or to offset employer contributions must be reallocated to participants. They also must be included in compliance testing in the year of reallocation. Noncompliance is considered an operational failure that can affect the tax-qualified status of the plan.

Employers should regularly monitor the plan-level forfeiture account to ensure forfeitures are used correctly and on time. Some plan providers make it easier to track activity by providing plan sponsors with regular forfeiture reports.

Cleaning the Slate in 2025

In 2025, the IRS will allow employers to address any accumulated balances in forfeiture accounts. You’re encouraged to take advantage of this relief year to treat forfeitures that were accumulated in previous plan years as 2024 plan-year forfeitures. This allows you to allocate forfeitures as part of your 2025 plan year-end annual compliance process.

Start planning now for your 2025 plan-year compliance testing. Review funds in the plan’s forfeiture account that were released before 2024. Ensure you use them to pay plan expenses, offset employer contributions or directly allocate them to participant accounts. Consult your adviser, third-party administrator or plan provider to review your plan document and determine the best ways to manage your forfeitures—this year and in the future.

Forfeitures in Action  

Below are some forfeiture scenarios based on guidance and transition relief for 2025.

Participant A left the company on June 30, 2024, with a retirement plan balance of $10,000. The participant took a lump-sum distribution that was 50% vested, with $5,000 deposited in the plan-level forfeiture account.

If not used to pay plan expenses or reduce employer contributions by 2025 plan year-end, the $5,000 must be reallocated to existing participant accounts and included as part of 2025 plan year-end compliance testing. (In this example, the timing and use of forfeitures follows IRS regulation.)

Participant B left the company on February 28, 2022, with a retirement plan balance of $5,000. The participant was 20% vested and took a lump-sum distribution of $1,000, with $4,000 deposited in the plan-level forfeiture account. The $4,000 in forfeitures from 2022 qualifies for transition relief in 2025.

If unused to pay plan expenses or reduce employer contributions by the 2025 plan year-end, the $4,000 must be reallocated to existing participant accounts and included as part of 2025 plan year-end compliance testing.

Participant C left the company on April 3, 2023, with a retirement balance of $80,000. The participant left the money in the retirement plan. No money was deposited in the plan-level forfeiture account because the participant has not reached a five-year break in service.

In this scenario, any non-vested employer dollars would remain in the participant’s account. When and if the employee reaches a five-year break in service, the non-vested dollars will move to the forfeitures account and would then be administered under IRS timing and use regulations.

It’s safe to say the IRS issued the 2023 proposed regulations to give employers time to align on the proper timing for using and allocating plan forfeitures.

Angela Trefethen is the senior director of retirement plans service at The Standard.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of ISS STOXX or its affiliates.