Lori M. Atkin is a Senior Counsel in Holland & Knight's Philadelphia office.
The Internal Revenue Service (IRS) has ruled that forfeitures under 401(k) plans can now be used to make qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs) to 401(k) plans. This recent change may lower the yearly amount of contributions a plan sponsor must make from corporate assets.
The Background
Sections 401(k) and 401(m) of the Internal Revenue Code mandate that employee contributions and employer-matching contributions to a 401(k) plan must satisfy certain nondiscrimination requirements each year. These nondiscrimination requirements can be met by passing annual tests. If annual nondiscrimination tests are not initially met, employers can still satisfy the nondiscrimination requirements by making QNECs and/or QMACs on behalf of nonhighly compensated plan participants.
Instead of passing annual nondiscrimination testing, some 401(k) plans have adopted a safe harbor formula, requiring the plan sponsor to contribute a certain level of QNECs and QMACs to eligible nonhighly compensated employees each year.
Previous U.S. Department of the Treasury regulations specified that QNECs and QMACs had to be nonforfeitable when they were contributed to the plan. This meant that employer contributions that were forfeited when participants terminated employment before being fully vested could not be used for QNECs or QMACs because such contributions were not nonforfeitable at the time they were applied to the plan.
What Changed
In January 2017, the IRS issued proposed regulations providing that QNECs and QMACs only had to be nonforfeitable when allocated to participant accounts, not when first contributed to the plan. These regulations have now been made final. If permitted by the plan, sponsors may now use forfeitures to fund QNECs and QMACs, for plan years ending on or after July 20, 2018.
Some commentators had expressed concern that midyear plan amendments permitting forfeitures to be used for QNECs and QMACs when the plan previously provided that forfeitures would be allocated to plan participants after payment of plan expenses would be an impermissible cutback. However, the preamble to the final regulations states that it is permissible to adopt such an amendment midyear, even if a participant had already completed the required number of hours of service to receive an allocation of forfeitures under prior plan provisions.
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