Most defined benefit (DB) plans can’t forfeit a participant’s benefit after 5 consecutive 1-year breaks-in-service. However, some DB plans have language that allows a forfeiture of a participant’s non-vested accrued benefit under two circumstances: when a participant terminates, or after the participant has 5 consecutive 1-year breaks-in-service. If the plan allows the employer to forfeit the non-vested benefit when the participant terminates, the plan must also state that the employer will restore the forfeited amount if the participant is rehired before having 5 consecutive 1-year breaks-in-service. This Issue Snapshot only addresses the involuntary cash-out rules that affect improper forfeitures of a participant’s vested accrued benefit by defined benefit plans. This Issue Snapshot does not address DOL Reg. Section 2530.204-1PDF DOL Reg. Section 2530.204-1, which discusses a year of service for benefit accruals. IRC Section and Treas. Regulation IRC Section 411(a)(6)(C) and (D) IRC Section 411(d)(3) IRC Section 411(a)(7)(B)(i) Analysis IRC Section 411(a)(6)(C) allows defined contribution (DC) plans and fully insured DB plans to forfeit the nonvested portion of the participant’s accrued benefit after 5 consecutive 1-year breaks-in-service. IRC Section 411(a)(6)(D)(i), also called the “rule of parity,” states that years of service (YOS) earned before a period of consecutive 1-year breaks-in-service is not be required to be taken into account if the number of consecutive 1-year breaks-in-service exceeds the greater of: (a) 5, or (b) the total number of YOS before the break. Under both IRC Sections, the accrued benefit earned before the participant has 5 consecutive 1-year breaks-in-service can’t be forfeited. The difference between the two IRC Sections is discussed below. 411(a)(6)(C) states that the YOS earned after the break-in-service (post-break service) do not have to be used to increase the vested percentage for the accruals earned before the break (pre-break accrued benefit). IRC Section 411(a)(6)(D) states that if a participant is not vested in any of his or her accrued benefit, then the YOS before earned the break (pre-break service) do not have to be used to determine his or her vesting percentage in the accrued benefit. In other words, for IRC Section 411(a)(6)(C), because a nonvested or partially vested participant who has 5 consecutive 1-year breaks-in-service can’t increase his or her vested percentage in the pre-break accrued benefit, the plan can forfeit the non-vested benefit that accrued before the 5 consecutive 1-year breaks-in-service. However, IRC Section 411(a)(6)(C) only applies to DC plans or fully insured DB plans. All other DB plans may not forfeit the partially vested or non-vested portion of his or her benefit that accrued before 5 consecutive 1-year breaks-in-service. Under IRC Section 411(a)(6)(D), when determining the total years of service required to calculate the vesting percentage for a non-vested participant who is rehired, a plan can disregard any YOS earned before a period of 1-year breaks-in-service if the number of 1-year breaks-in-service is greater than: (a) 5, or (b) the total number of YOS before the period of 1-year breaks in service. IRC Section 411(a)(6)(D) does not apply to partially vested participants. IRC Section 411(a)(7)(B)(i) allows plan documents (including DB documents) to provide: immediate involuntary distribution of the vested accrued benefit when the participant terminates if the amount does not exceed the IRC Section 411(a)(11)(A) dollar limit, and immediate forfeiture of the non-vested portion of the accrued benefit. To contain this provision, the plan document must state that the employer will make involuntary distributions to a participant when he or she terminates. The plan must also state that the employer will reinstate the forfeited amount if the participant timely repays the distribution when rehired. In other words, a plan document that includes a “cash out” provision must also contain repayment or “buy back” language. Example 1 Plan A, a non-insured DB plan, states that the plan will forfeit a participant’s non-vested accrued benefit when he or she terminates. The plan also states that if a participant is rehired before having 5 consecutive breaks-in-service, the plan will restore the non-vested accrued benefit that was forfeited when he or she terminated. The plan document has a 5-year cliff vesting schedule. The plan language includes the “rule of parity,” but doesn’t include cash-out or “deemed” cash-out distribution* language. Taylor started working for company A and started earning YOS for vesting and benefit accruals. He completed 4 YOS for vesting and accrual purposes. The present value of his accrued benefit under the plan was $1,000 after 4 years. Taylor terminated and has 4 consecutive 1-year breaks-in-service. Based on the plan terms, Plan A forfeits his total accrued benefit of $1,000, as he was zero percent vested. Taylor is rehired and earns a year of service before he has 5 consecutive 1-year breaks-in-service. Based on the plan terms, the plan reinstates the $1,000 accrued benefit that the plan forfeited when he terminated. Solution: The fact that the plan reinstated Taylor’s $1,000 forfeited accrued benefit when he was rehired does not negate the fact that the plan improperly forfeited his accrued benefit. The plan can’t use the provisions of IRC Sections 411(a)(6)(C) or (D) to forfeit Taylor’s accrued benefit, because he was rehired and earned a year of service before having 5 consecutive 1-year breaks-in-service. The plan can’t use the provisions of IRC Section 411(a)(7)(B)(i) to forfeit his non-vested accrued benefit, because the plan had no cash out or “deemed” cash out provisions. Some taxpayers argue that there is no improper forfeiture, since the plan allows for the restoration of his accrued benefit. However, IRC Section 411(d)(3) requires the employer to fully vest all affected participants if there is a full or partial termination of the plan. The plan would have to fully vest Taylor in his accrued benefit of $1,000 if there was a full or partial termination of the plan before he was rehired. He would be an affected participant under IRC Section 411(d)(3). The plan improperly forfeited his accrued benefit when he terminated. Example 2 Plan B, a non-insured DB plan, states that the plan will forfeit a participant’s non-vested accrued benefit when he or she terminates. If the participant is rehired before having 5 consecutive breaks-in-service, the plan will restore the non-vested accrued benefit that was forfeited when he or she terminated. The plan uses a 7-year graded vesting schedule. The plan language includes the “rule of parity,” but doesn’t include cash out or a “deemed” cash out distribution* language. Taylor started working for company B and started earning YOS for vesting and benefit accruals. He completed 4 YOS for vesting and accrual purposes. The present value of his accrued benefit under the plan was $1,000 after 4 years. Taylor leaves company B after earning 4 years of vesting service. Based on the plan’s vesting schedule, he is 40% vested in his accrued benefit as of the date he terminates. Based on the plan’s terms, the plan forfeits $600 of Taylor’s accrued benefit, which represents the non-vested portion of his accrued benefit. Taylor is rehired after having 5 consecutive 1-year breaks-in-service. Based on the plan’s terms, the plan does not restore his non-vested accrued benefit as he was rehired after having 5 consecutive 1-year breaks-in-service. Solution: Plan B improperly forfeited $600 of Taylor’s accrued benefit. The plan can’t forfeit his non-vested accrued benefit under IRC Section 411(a)(6)(C), as the plan is a non-insured DB plan. IRC Section 411(a)(6)(C) only applies to a DC plan or a fully insured DB plan. Plan B may not use the “rule of parity” provisions of IRC Section 411(a)(6)(D) to ignore the YOS earned before he had 5 consecutive 1-year breaks- in- service as the “Rule of Parity” only applies to a non-vested participant. The plan didn’t have cash out provisions, so the plan can’t forfeit his non-vested accrued benefit under IRC Section 411(a)(7)(B)(i). As in example 1, the plan would have to fully vest Taylor in his accrued benefit of $1,000 if there was a full or partial termination of the plan before he was rehired. He would be an affected participant under IRC Section 411(d)(3). Issue Indicators or Audit Tips If the plan is a non-insured DB plan, determination specialists and examiners should confirm that the plan document doesn’t allow the plan to forfeit a participant’s non-vested accrued benefit if he or she has 5 consecutive 1-year breaks-in-service. A noninsured DB plan can’t forfeit a participant’s accrued benefit without cash out or “deemed” cash out language. If the plan is trying to use the “rule of parity” to ignore years of service earned before a break in service, determination specialists and examiners should ensure that the provisions of IRC Section 411(a)(6)(D) apply only to non-vested participants. If a DB plan has a full or partial termination, all of the affected employees must be 100% vested in their accrued benefits. Review the account of any current or former participant who didn’t receive a distribution of his or her entire accrued benefit to ensure that there are no improper forfeitures. * A plan can provide that an employee is deemed to have received a distribution of their vested accrued benefit if the present value of the vested accrued benefit is zero and if the plan includes the proper repayment language.
