401(k) Plan Forfeitures
What are plan forfeiture assets and what they mean for plan sponsors.
What is a plan forfeiture?
When a 401(k) plan includes vesting requirements on employer contributions, any portion of an employee's balance that has not fully vested undergoes a process known as a plan forfeiture when that employee leaves the company. The unvested portion of their balance is reclaimed by the plan. These forfeited amounts are typically retained within the plan until they are put to use.
What needs to be done with these assets?
The proper handling of assets is essential. These assets can be used towards covering administrative costs or to cover employer contributions. As a fundamental rule-of-thumb, it's crucial to utilize forfeitures without delay, avoiding their retention beyond the plan year in which they originated.
The IRS provides clear directives in this regard:
- Unallocated forfeitures within an account should not persist beyond the conclusion of the plan year in which they materialized.
- Forfeited amounts should not be carried over into subsequent plan years.
- In cases where forfeitures are utilized to offset plan expenses or employer contributions, there must exist plan language and administrative protocols within the plan document. These ensure that forfeitures are promptly utilized in the year they arose or, if suitable, in the subsequent plan year.
The 401(k) plan document should explicitly define the course of action for managing forfeiture assets within a given plan. Plans operating under the Betterment at Work platform often incorporate a provision that enables Betterment to allocate forfeiture funds toward upcoming payrolls.
What happens if these assets are not properly managed?
Not adhering to the specified timing rules for using forfeitures could lead to a problem with plan qualification. This is usually known as an operational failure as the plan rules are not being followed.
If the timely utilization of plan forfeitures was not met, remedies can be pursued through the IRS Employee Plans Compliance Resolution System (EPCRS). If the error is minor or is rectified by the end of the second plan year after its occurrence, it can often be resolved through self-correction (SCP) without involving the IRS. However, if the issue is more substantial, it would require action by formally submitting a request to the IRS under the Voluntary Correction Program (VCP).
To ensure proper handling, plan sponsors must align their plan documents with timely forfeiture usage guidelines and establish a procedure to ensure their appropriate application.
Betterment has you covered.
When you use Betterment at Work to administer your organization’s 401(k) plan, our team will automatically handle the forfeiture process (and keep you in the loop as the plan’s fiduciary).