As a way of encouraging long-term employment, employee benefit plans often provide a combination of vested and non-vested assets. When employees leave a company before their employer contributions have vested, they may forfeit those amounts based on how long they worked for the employer.

Choices with Forfeited Dollars

As a plan sponsor, you have four choices regarding what to do with forfeited dollars:

  • Use them to offset plan expenses;
  • Tap them to offset amounts needed for matching contributions for active participants;
  • Reallocate them evenly among active participants; and
  • Return forfeited funds to former plan participants who rejoin the plan.

Many plan documents require forfeitures to first be used to offset employer contributions, with any remainder used to pay plan expenses. The plan document will also state when these forfeitures are allocated, so it is important to follow the procedures. You cannot let these amounts accumulate indefinitely. The IRS and Department of Labor suggest reducing the forfeiture balance to zero at least once every plan year.

What Does Your Plan Document Say?

Your plan document should describe your forfeiture policy. However, sometimes plan administrators do not review their plan documents, which causes forfeitures to be handled inconsistently. Be sure that your administrative practice is current with your plan document.

When you started the plan, it is possible that you did not give much consideration to the forfeiture options. You may have unintentionally used boilerplate language. When you review your document, it is important to think about whether or not it is consistent with your current philosophy and if it meets your practical needs.

For example, if you currently distribute forfeitures among active participants but are looking for ways to lower plan expenses, you could amend your plan document to use forfeitures to offset plan fees.

How Do You Define Forfeiture?

Another important policy decision is to define the timing of forfeiture. Generally, it occurs immediately following a participant's separation of service. The plan document will state when the forfeiture will occur. The key is to administer the plan according to its terms. A violation of the terms may jeopardize the plan's qualified status. If this occurs, the voluntary correction program of the IRS is available for assistance. As always, if you have questions about your plan document, talk with us for other possible solutions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.