Fixing Common Plan Mistakes - Improper Forfeiture Suspense Accounts

The Issue

Many defined contribution plans require participants to complete a period of service before becoming fully vested in matching or nonelective employer contributions. If a participant leaves a company before completing the service required for full vesting, his or her non-vested account may be forfeited. Some plan administrators place these forfeited amounts into a plan suspense account, allowing them to accumulate over several years. The Internal Revenue Code does not allow this practice.

Find the Mistake

Forfeitures must be used or allocated in the plan year incurred. The Code does not authorize forfeiture suspense accounts to hold unallocated monies beyond the plan year in which they arise. Revenue Ruling 80-155 states that a defined contribution plan will not be qualified unless all funds are allocated to participants’ accounts in accordance with a definite formula defined in the plan. This would preclude a plan from carrying over plan forfeitures to subsequent plan years, as doing so would defy the rule requiring all monies in a defined contribution plan to be allocated annually to plan participants. Revenue Ruling 84-156 states that forfeitures may be used to pay for a plan’s administrative expenses and/or to reduce employer contributions. Treasury Regulations §1.401-7(a) notes that forfeitures must be used as soon as possible to reduce employer contributions.

The plan document’s terms should have provisions detailing how and when a plan will exhaust plan forfeitures. A plan’s failure to use forfeitures in a timely manner denies plan participants additional benefits or reduced plan expenses.

Common causes for this error include:

• The plan’s sponsor and/or third party administrator fails to monitor the plan’s forfeiture account to ensure that forfeitures generated in that plan year are used according to the plan’s terms.
  
  
• The plan sponsor erroneously thinks that he or she has discretion over how and when forfeiture monies in the suspense account can be applied.
  
  
• Plan document terms are vague in describing how forfeitures are to be handled and results in the plan’s document and operation being inconsistent with the holdings in Revenue Rulings 80-155, 84-156 and the Code.

Fix the Mistake

Generally, this failure can be corrected by reallocating all forfeitures in the plan’s forfeiture suspense account to all plan participants who should have received them had the forfeitures been allocated on time. The plan sponsor should revise prior plan year allocation reports to reflect the forfeiture allocation and pay any amounts due to terminated participants. Depending on the plan terms or the facts and circumstances of a particular situation, it may be appropriate to take the non-current-year forfeitures and use them as employer contributions for the current plan year. Plan sponsors should apply the correction principles in Revenue Procedure 2008-50, section 6 when making correction.

Plan sponsors can correct this mistake using the Employee Plans Compliance Resolution System (EPCRS). Using the Self-Correction Program, the mistake must generally be fixed within two years following the close of the plan year in which it occurred. Unless the failure can be classified as insignificant, the Voluntary Correction Program must be used after this time. VCP must also be used if the plan document terms are defective and need to be corrected retroactively by a plan amendment.

Avoid the Mistake

Plan sponsors and third party administrators need to monitor plan forfeitures. If a suspense account is used, then they must ensure that all forfeitures for a plan year are promptly used according to the plan’s terms.

• No forfeitures in a suspense account should remain unallocated beyond the end of the plan year in which they occurred.
  
  
• No forfeiture should be carried into a subsequent plan year.
  
  
• For those plans that use forfeitures to reduce plan expenses or employer contributions, there should be plan language and administrative procedures to ensure that current year forfeitures will be used up promptly in the year in which they occurred or in appropriate situations no later than the immediately succeeding plan year.