On February 27, 2023, the Treasury issued proposed regulations intended to simplify and clarify the rules relating to forfeitures within qualified retirement plans.

Defined Benefit Plans

Similar to defined contribution plans, defined benefit plans may use forfeitures to pay eligible plan expenses. However, unlike defined contribution plans, defined benefit plans are prohibited from using forfeitures to reduce required employer contributions. In addition, forfeitures must be used as soon as possible. The proposed regulations eliminate this timing requirement because it conflicts with the minimum funding requirements. Instead, reasonable actuarial assumptions are to be used to determine how expected forfeitures will affect the present value of plan liabilities. The difference between expected and actual forfeitures will then increase or decrease the plan’s minimum funding requirement in future years.

Defined Contribution Plans

In contrast to defined benefit plan restrictions, defined contributions plans are permitted to use forfeitures to reduce employer contributions or increase benefits. Specifically, current regulations include uniform rules for the use of forfeitures in defined contribution plans (for example, 401(k) and profit-sharing plans) that permit forfeitures to 1) be allocated as additional contributions to participants in accordance with plan provisions, 2) be used to reduce future employer contributions, and 3) pay eligible plan expenses. The plan document should specify how and when forfeitures will be used.

The proposed regulations clarify these uses for forfeitures in defined contributions plans (which for this purpose includes money purchase pension plans) and require that all forfeitures be used no later than 12 months following the plan year in which the forfeiture occurs. An operational qualification failure will occur if forfeitures remain unallocated at the end of the 12-month period following the end of the plan year.

The proposed regulations are intended to simplify the administration of forfeitures, but the Treasury doesn’t expect the changes will have much impact on current plan operations. The regulations, if finalized, will be effective for plan years beginning on or after January 1, 2024.

To prepare, review plan documents to be sure that terms and operations are consistent with the proposed regulations (for example, be sure defined contribution plans include provisions that permit the use of forfeitures for all permitted uses to avoid having excess forfeitures remaining at year end).