After reading Part 1, I’m sure you requested your forfeiture account statements, and then ran right to your plan document to check the forfeiture provisions. Now that you have a firm grip on the forfeiture account balance and how these assets can be used, let’s discuss when you should use them, and why going through this exercise may save you time and money.
WHEN TO USE FORFEITURES:
Most plan documents also provide for a specific timeframe in which forfeitures should be used that conforms to the IRS’s requirements for the treatment of unallocated assets in a defined contribution plan. Generally, plans require that forfeitures be used within one of two timeframes: (1) the same plan year in which the forfeiture occurred; or (2) before the end of the following year. If your plan document does not specifically identify a timeframe, then to be safe, you should adhere to the more conservative time frame and ensure that forfeiture assets are used no later than the end of the year in which they were forfeited. In any event, do NOT hold or carry over forfeitures longer than the plan document allows.
For the record, the same plan year will typically include any forfeitures used to offset an expense or contribution incurred during the prior plan year. As a common example, if your pay period ended December 28, 2014, but your employees were not paid until January 2, 2015, then using forfeitures to offset an employer contribution effective January 2, 2015 would be considered a use of forfeitures during the 2014 plan year. Similarly, using forfeitures to pay an invoice on January 2, 2015 for services rendered during the 4th quarter of 2014 would be considered a use of forfeitures during the 2014 plan year.
WHY IT MATTERS:
It may seem straight-forward, but in the commotion of daily plan administration, it’s easy to forget that you need to use the forfeiture assets in a specific order, or that forfeited assets from prior years are gathering dust. However, using forfeitures improperly or failing to use forfeitures within the right timeframe can cause some serious headaches.
Forfeiture account problems are easy to identify during an IRS or DOL audit (full disclosure: the author is a former DOL investigator), and then an already complicated correction process will be subject to their review before you can clear the audit. Even if you take independent action, fixing the mistake under the IRS’s self-correction program can be very complicated and time-consuming, and the DOL has no applicable self-correction program that can put your mind at ease.
A correction becomes particularly difficult if a plan has failed to use its forfeitures for multiple years. For each year the forfeitures were not used, every participant may have been affected, and will be subject to the correction. This means that figuring out the corrective allocation will require you to sift through multiple years’ census data to determine who was harmed and in what amount, and you must also make supplemental distributions for affected participants that no longer hold plan accounts. Further, depending on how your plan document allows you to use forfeitures, a corrective allocation may need to be in the form of a profit sharing contribution, and a significant allocation to your Key Employees and Highly Compensated Employees may throw off your top heavy and discrimination testing. Finally, if you’ve cleaned out your forfeiture account after carrying over assets for multiple years and discover after the fact that participants have been harmed, then you may end up making a payment to the plan out of pocket to cover the difference.
Even correcting a simple improper use can be an administrative hassle and result in unnecessary out-of-pocket costs. For example, if you offset employer matching contributions instead of expenses when the plan document requires expenses be paid first, then determining which participants were actually affected and in what amount can be a difficult proposition. Some participants received a matching contribution allocation, but it may have been less than they would have received if administrative expenses had been paid first. On the other hand, non-contributing participants may have had expenses deducted from their account without receiving any matching contributions. If it sounds exhausting, that’s because it is exhausting. This is only one simple misuse of forfeitures, and keep in mind that you may end up paying the costs associated with squaring away the mess.
Save yourself some aggravation, and make sure that you are familiar with your forfeiture account balance and your plan document’s treatment of forfeitures. An ounce of prevention is worth a pound of cure, and with a new year on the horizon, it is more important than ever that you get your forfeitures squared away before that good money turns bad.