IRS Proposes New Rules on Retirement Plan Forfeitures: What Employers Need to Know

In February 2023, the IRS released proposed regulations that directly impact how employers handle forfeitures in qualified retirement plans. These changes apply to defined contribution (DC) plans, such as 401(k)s, as well as defined benefit (DB) pension plans.

What Are Forfeitures?

Forfeitures occur when a participant leaves employment before becoming fully vested in employer contributions. The unvested amounts are returned to the plan and can be used for specific purposes, such as:

• Reducing future employer contributions
• Paying plan administrative expenses
• Reallocating funds among participants (for DC plans)
• Reducing required employer contributions (for DB plans)

For years, there was little clarity on when exactly forfeitures needed to be used. As a result, some employers allowed forfeiture balances to accumulate in plan accounts for years.

As a side note, there have been several lawsuits filed on behalf of participants that claim that using forfeitures for reducing future employer contributions is a breach of fiduciary duty to the participants of the plan by the plan sponsor. The Department of Labor has indicated that since the Employee Retirement Income Security Act (ERISA) allows all the above treatments of forfeitures, they don’t believe using forfeitures as described in the plan document, in compliance with ERISA rules, is a breach of fiduciary duty.

What Changed?

The proposed regulations are scheduled to take effect for plan years beginning on or after January 1, 2024, and now require that forfeitures be used no later than 12 months after the end of the plan year in which they arise for DC plans. Any forfeitures from plan years before 2024 are treated as if they occurred in the 2024 plan year, meaning sponsors have until the end of 2025 to apply them under the transitional relief to avoid penalties.

For DB plans, the proposed regulations eliminate wording that forfeitures must be used “as soon as possible” and instead forfeitures should be factored into a plan’s minimum funding requirements using reasonable actuarial assumptions.

Why It Matters for Employers

For employers sponsoring retirement plans, these changes mean tighter timelines, more careful recordkeeping, and potential plan document updates. Failure to use forfeitures in a timely manner could lead to plan qualification issues and penalties.

Additionally, plan sponsors should review how forfeitures are tracked and ensure coordination with their third-party administrators (TPAs), recordkeepers, and ERISA counsel to stay compliant.

If your current plan operations allow forfeiture balances to accumulate across plan years, you will likely need to make procedural adjustments before the end of 2025 to align with these new requirements.

What You Should Do Now

• Review plan documents to confirm how forfeitures are permitted to be used.
• Coordinate with your TPA or recordkeeper to ensure forfeitures are being tracked and used within the required timeframe.
• Evaluate internal processes for plan funding and expense allocation.
• Document any changes in plan procedures for audit readiness.

Bottom Line

The IRS’s new proposed guidance provides more clarity on how forfeitures are allowed to be used and places responsibility on employers to manage forfeitures more proactively. Whether you sponsor a 401(k), a pension plan, or both, now is the time to revisit your forfeiture procedures and ensure full compliance before the end of 2025.

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