The Wagner Law Group | Est. 1996

Sophisticated Legal Solutions And Boutique-Style Service

IRS Issues Proposed Regulations Regarding Use of Forfeitures in Tax-Qualified Plans

by | Mar 14, 2023 |

By Jon Schultze and Barry Salkin

Some of the IRS regulations dealing with tax-qualified plans predate ERISA and subsequent federal tax legislation, and have become outdated. However, sometimes it takes IRS a long time to update its regulations to reflect current law. On February 24, 2023, the IRS issued proposed regulations addressing one such outdated regulation.

In 1963, IRS issued regulations governing the use of forfeitures in pension plans, a category that includes both defined benefit plans that promise a stated (“defined”) benefit and money purchase pension plans which promise a stated (“defined”) contribution that is held in a participant’s individual account and grows with earnings until paid out at retirement. Under the 1963 regulations, forfeitures in a defined contribution pension plan could not be used to increase any participant’s benefit; in a defined benefit pension plan; forfeitures were required to be used to reduce employer contributions. In 1986, the Tax Reform Act changed the law to allow forfeitures in defined contribution plans to be reallocated to other participants, and by the mid-1970’s ERISA’s funding rules had already rendered the 1963 regulations obsolete for defined benefit plans.

For defined benefit pension plans, the proposed regulations require reasonable actuarial assumptions to be used to determine the effect of expected forfeitures on the present value of a plan’s liabilities under the plan’s funding method. With respect to defined contribution plans, the proposed regulations allow forfeitures to be used to pay plan administrative expenses; reduce employer contributions to the plan; or increase benefits in other participants’ accounts. The preamble to the proposed regulations states that employer contributions would include the restoration of inadvertent benefit overpayments and of conditionally forfeited participant accounts.

The proposed regulations also address the timing of  the use of forfeitures by generally requiring that plan administrators use forfeitures no later than 12 months after the end of the plan year in which they arise. Under a transition rule relating to this twelve-month deadline, any forfeitures that occur in a plan year beginning before 2024 are treated as having been incurred in the first plan year beginning after 2023.

As a plan design issue, the IRS recommends that a plan provide for the use of forfeitures for more than one permissible purpose, noting that if a plan’s use of forfeitures is restricted to one purpose and the forfeitures in any year exceed the amount needed for that purpose, the plan would have an operational failure unless it is amended to provide also for the use of forfeitures for additional purposes.