This is the final article of a three-part series that provides guidance for plan sponsors who are faced with cash flow pressures at their business. (You can find the first article here and the second one here). The goal of the series is to offer alternative solutions to consider before reducing employer contributions to participant benefit accounts.
As much as everyone wishes it would go away, the coronavirus pandemic remains a threat to many businesses and to employee retirement savings. Plan sponsors searching for ways to sustain contributions to company qualified retirement plans should look closely at forfeitures to help reduce expenses and help their workers save for their financial future.
When applied correctly per the terms of a company’s retirement plan, forfeiture dollars could be an invaluable source of cash – and should be the first accounts to analyze before contemplating an amendment to reduce the employer match or change contributions.
What are plan forfeitures?
Forfeitures, for plan sponsors unfamiliar with the term, are the non-vested portions of former employees’ account balances that are in a company retirement plan. Once employees who are not fully vested are terminated and take distributions, these unvested dollars are tracked and recorded in a special account in the retirement plan’s accounting called forfeitures.
Benefits executives must always remember that forfeitures are plan assets. These amounts have been added to the plan balance and allocated to participant accounts. As plan assets, the plan document will contain language that controls how forfeitures can be used. Examples include paying plan administrative expenses or reducing employer contributions. Forfeiture dollars not applied per the terms of the plan document would be considered a breach of fiduciary duty by the employer and put the plan at risk of losing its qualified status with the IRS.
Forfeitures are tied to the plan’s vesting schedule (which may be nonexistent in some safe-harbor 401(k) plans). It is not uncommon for forfeiture dollars to build up within the forfeiture account. Oftentimes, the plan’s auditor will notify benefits executives that the balance needs to be allocated per the terms of the plan’s forfeiture provisions.
Applying plan forfeitures
In many circumstances, plan sponsors can treat unvested amounts in a participant’s account as forfeitures, even though a participant has not taken a distribution. This will depend largely on the specific terms of the plan document. A common issue centers on the unvested balances of accounts of terminated participants who have five consecutive years of break in service but have not worked for the company for more than five years. Depending on the plan’s forfeiture provisions, those dollars generally could be reclassified and added to the forfeiture balance.
Plan sponsors should also review the vested account balances of terminated participants. A generally accepted best practice is to maintain accurate address and contact information for former employees who have participated in the company’s retirement plan.
Administrative problems often arise when employers lose contact with plan participants and they reach the age of required minimum distributions (RMDs). A qualified plan is required to distribute these funds to those individuals. Generally, these small, vested balances can be distributed to the participants or transferred into an individual retirement account in the participant’s name and the unvested portion placed in the forfeiture account.
By understanding plan provisions for forfeitures, plan sponsors will be in a better position to leverage use of those funds to maintain the company’s retirement plan contributions. It’s also a healthy play because it encourages the timely distribution of funds to former employees when they reach RMD. Most importantly, it will help employees by giving them financial peace of mind, knowing that their employer is going the extra mile to sustain the company’s retirement plan during the most challenging economic period of our generation.