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If you make contributions to your employee’s 401k plan, you may have built up amounts called forfeitures.
What is a forfeiture account? A forfeiture is the non-vested portion of an employee’s account balance. For example, if an employee is 40% vested in your profit-sharing plan terminates their employment with your company, the remaining 60% becomes a forfeiture.
IRS revenue ruling 84-156 states that forfeitures can be used to pay for a plan’s administrative expenses and/or to reduce employer contributions. This is determined based on the provisions of the plan. Forfeiture accounts typically pay the administrative expenses of the plan.
These expenses include accounting, auditing, record-keeping, or consulting fees. If there are forfeitures remaining after expenses have been paid, the plan will indicate how they will be used.
In most cases, any remaining forfeitures are used to reduce the employer contribution or be allocated to other employee’s plans. Employer contributions offset by forfeiture accounts are not tax-deductible, and cannot be used for employee deferrals. Forfeiture account funds also cannot be distributed back to the employer.
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Assets in a forfeiture account should be used in the year the employee terminated their employment. Typically, no later than the end of that year. You’re not allowed to let forfeitures accumulate from year to year before using them, no matter how small the amount is. Any forfeitures left over from one year to the next must be used to pay expenses for the following year.
To make sure that forfeitures are used properly you should monitor your account frequently.
Just like anything else in business, you need to plan on how you use forfeitures. There are many options when it comes to utilizing forfeitures. Be sure to go over your plan to make sure it aligns with your goals.
You need to understand when forfeitures will occur, how to use them, and when to use them. Failure to understand these could lead to IRS violations.. So, if your employees ask you what is a forfeiture account, you can tell them.
Have more questions about forfeiture accounts? Schedule a plan discussion with us or take 30 seconds to find which plan is best for your company with the retirement plan evaluator.