The Employee Plans Division of the IRS regularly publishes a newsletter entitled "Retirement News for Employers (RNE)." Each issue of the newsletter looks at a common error in retirement plans and explains the IRS' position on fixing the problem and reducing the probability of its recurrence. In the Spring 2010 issue, the IRS discussed the operation of suspense accounts (or "unallocated" accounts) that are attributable to forfeitures from participants' accounts.

Each issue of the RNE examines a common error that occurs in retirement plans and provides information on fixing the problem and reducing the probability of its recurrence.

The Issue
Many defined contribution plans require participants to complete a period of service before becoming fully vested in matching or nonelective employer contributions. If a participant leaves a company before completing the service required for full vesting, his or her non-vested account may be forfeited. Some plan administrators place these forfeited amounts into a plan suspense account, allowing them to accumulate over several years. The Internal Revenue Code does not allow this practice.

Find the Mistake
Forfeitures must be used or allocated in the plan year incurred. The Code does not authorize forfeiture suspense accounts to hold unallocated monies beyond the plan year in which they arise. Revenue Ruling 80-155 states that a defined contribution plan will not be qualified unless all funds are allocated to participants' accounts in accordance with a definite formula defined in the plan. This would preclude a plan from carrying over plan forfeitures to subsequent plan years, as doing so would defy the rule requiring all monies in a defined contribution plan to be allocated annually to plan participants. Revenue Ruling 84-156 states that forfeitures may be used to pay for a plan's administrative expenses and/or to reduce employer contributions. Treasury Regulations §1.401-7(a) notes that forfeitures must be used as soon as possible to reduce employer contributions.

The plan document's terms should have provisions detailing how and when a plan will exhaust plan forfeitures. A plan's failure to use forfeitures in a timely manner denies plan participants additional benefits or reduced plan expenses.

We hope this information will be helpful to you. If you have questions, contact any of our benefits attorneys.
Source: The Report to PLANSPONSOR