The IRS has taken an official position that forfeitures may not be used to fund mandatory employer contributions to safe harbor Section 401(k) plans, and employers are unhappy about the prospect of no longer having forfeitures as a source of funds for those contributions, according to an attorney familiar with the recent IRS interpretation.
The IRS interpretation of tax code Sections 401(k) and 401(m) conflicts with the current practice of employers that have been using forfeitures to make safe harbor contributions, especially in years when they find it financially difficult to fund those contributions from company profits, David Schultz, a partner at HA&W Wealth Management.
Practitioners learned of the official IRS position on forfeitures and safe harbor contributions in October, when the agency released a 134-page document:
Cash or Deferred Arrangement (CODA): Listing of Required Modifications and Information Package (LRMs) (For use with master or prototype (M&P) plans intending to satisfy the requirements of Code §§ 401(k) and 401(m).).
Forfeitures generally refer to benefits that employees cannot take with them when they leave an employer before all of their accrued benefits become vested. Safe harbor contributions, described in Section 401(k)(12) and (13), are qualified matching or nonelective contributions that employers can make to avoid actual deferral percentage (ADP) testing under tax code Section 401(k) or actual contribution percentage testing under tax code Section 401(m). Cash or deferred arrangement is an IRS technical term for a Section 401(k) plan.
The IRS is interpreting sections 401(k) and 401(m) to mean that safe harbor contributions must be nonforfeitable at the time they are made to the plan trust, whereas many practitioners have understood the law to mean that safe harbor contributions must be nonforfeitable at the time they are allocated to the participants' accounts, Schultz said.
The change will not happen immediately, Schultz said. The restrictions on forfeitures will be reflected in new plan documents.
The American Society of Pension Professionals and Actuaries wrote to the IRS to reconsider the interpretation reflected in the recent LRMs by:
- Permitting the use of forfeitures for ADP safe harbor contributions and qualified matching contributions, assuming the contributions become nonforfeitable once they are allocated and are not subject to a vesting schedule; and
- Clarifying that the agency's “nonforfeitable” requirement does not apply to ADP safe harbor contributions made to qualified automatic contribution arrangements, which may be subject to a vesting schedule.
The LRMs are available on the
IRS website.