On February 24, 2023, the IRS issued proposed regulations simplifying the use of forfeitures in qualified retirement plans, providing that forfeitures in defined contribution plans must be used by the end of the plan year following the year in which the forfeitures arise. Plan sponsors can rely on the proposed regulations effective immediately.

Timing for Use of Defined Contribution Plan Forfeitures

The IRS had previously provided informal guidance in its Spring 2010 Employee Plans newsletter regarding the timing for use of forfeitures in defined contribution plans. The guidance indicated that forfeitures should generally be used no later than the year in which the forfeitures arose, but included somewhat cryptic language indicating that forfeitures could be used by the end of the following year in “appropriate situations,” without defining those situations. This has led to some confusion among plan sponsors regarding the deadline for using forfeitures, particularly when the forfeitures arise late in the year, making it difficult to use them in that same year.

The proposed regulations revise Treasury Regulation section 1.401-7(b) to require that forfeitures are used “no later than 12 months following the close of the plan year in which the forfeitures were incurred under plan terms.” This simplified and practical approach will likely be welcome news for plan sponsors and recordkeepers. The proposed regulations also include a helpful transition rule that would allow amounts that have been forfeited in any plan year that begins before January 1, 2024 to be treated as having been forfeited in the first plan year that begins on or after January 1, 2024.

Permitted Uses of Defined Contribution Forfeitures

Forfeitures cannot revert to the employer, and prior IRS guidance specifies that permitted uses of forfeitures include reducing employer contributions and paying plan expenses. The proposed regulations would update Treasury Regulation section 1.401-7(b) to explicitly state these permissible uses, allowing defined contribution plans to use forfeitures to:

• pay plan administrative expenses,
• reduce employer contributions under the plan, or
• increase benefits in participants’ accounts in accordance with plan terms.

Use of Forfeitures in Defined Benefit Plans

Treasury Regulation section 1.401-7(a) currently provides that forfeitures must be used as soon as possible to reduce an employer’s contributions under the plan, and that an employer may anticipate the effect of forfeitures in determining its costs under the plan. However, this is inconsistent with the minimum funding requirements, which require employers to use reasonable actuarial assumptions to estimate the effect of expected forfeitures of plan liabilities. Therefore, the proposed regulations delete this provision and add a specific reference to the minimum funding rules. This comports with current practice regarding forfeitures in defined benefit plans, so it is not a change that will impact plan administration.

Effective Date of Regulations

The regulations are proposed to be effective for plan years beginning on or after January 1, 2024. In the meantime, plan sponsors may rely on the proposed regulations. The IRS also requested comments on the proposed regulations, including further simplifications that may be possible, by May 30, 2023.

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