The short answer – is yes.
A recent blog post by Jackson Lewis’ Randal Limbeck notes that not only is it imperative that forfeitures be handled properly, but that he is aware of situations where forfeiture accounts do indeed violate the ERISA requirements. Moreover, Limbeck cautions that both the IRS and the Department of Labor (DOL) on audit generally review how forfeitures have been handled by the plan.
The basic rule is that forfeitures must be allocated on an annual basis, not held over into later years. Failure to comply with this requirement can result in disqualification of the plan or potential penalties imposed by the DOL, he notes, though sometimes this failure is due to an accidental failure to timely deal with the forfeitures.
That’s the 'when,' of course. But what about the 'how'?
Well, Limbeck explains that that depends upon the terms of the 401(k) plan. For example, you can’t use forfeitures to pay plan expenses if the plan document doesn’t allow for that.
Forfeitures can, of course, be used to reduce employer contributions, including matching contributions and non-elective contributions. They can also be reallocated to participants’ accounts as an additional amount for participants.
However, Limbeck cautions that the IRS has recently taken the position that forfeitures cannot be used to offset safe harbor contributions under a regular or QACA safe harbor plan, and that using them for safe harbor contributions can also result in plan disqualification. Additionally, he explains that forfeitures cannot be used for certain corrections under the IRS Employee Plans Compliance Resolution System (EPCRS).
Dealing with Carryovers
When a regulatory agency determines that forfeitures have been carried over, the agencies may require the plan sponsor to retroactively determine who should have received allocations each year.
Limbeck notes that if the plan has a forfeiture account that includes amounts carried over from one year to another, you should review that account and take appropriate action so that the account does not include any carryovers. Of course, this creates a monetary burden and a significant administrative burden on employers.