The IRS recently issued welcome guidance for sponsors of 401(k) plans. On January 18th, the IRS issued proposed regulations that permit forfeitures to be used to fund the employer’s safe harbor contributions, qualified nonelective contributions (QNECs), and qualified matching contributions (QMACs). This guidance reverses the IRS’s prior interpretation of the law to require that such contributions be nonforfeitable at the time they are contributed to a plan.

Under this prior interpretation, the IRS required that language be included in plan documents that prohibited the use of forfeitures to fund safe harbor contributions. Many plan sponsors were hamstrung if there were forfeitures in their plans, but they only intended to make safe harbor contributions, and they could not use all of the forfeitures to pay plan expenses. This new proposed regulation would allow the forfeitures to be used to reduce the employer’s safe harbor contributions and to fund QNECs and QMACs.

The proposed regulations will become effective for taxable years beginning on or after the date the final regulations are published. However, the IRS has stated that these proposed regulations may be relied upon immediately.

Please note that, in order to use forfeitures to fund safe harbor contributions, QNECs or QMACs, the plan document must be amended to remove any language that prohibits using forfeitures to fund safe harbor contributions.

This is a refreshing action by the IRS, and it is clear that the IRS has listened to practitioners and plan sponsors about the need for this change.