Use of Forfeitures in Safe Harbor 401(k) and 403(b) Plans

Kimberly Flett

The IRS issued proposed regulations stating Qualified Non-Elective Contributions (QNECs) and Qualified Matching Contributions (QMACs) will be considered non-forfeitable at the time allocated to participant accounts.

Previously the forfeiture amounts could only be applied to sources of funding subject to a vesting schedule, such as profit sharing. Certain pre-approved plan documents must have included language prohibiting the use of forfeitures to fund safe harbor contributions. This caused challenges for plan sponsors in terms of funding within various sources as part of plan administration.

401(k) plans must satisfy certain discrimination tests to ensure the plan contribution amounts do not favor highly compensated employees. Deferral and matching contributions in particular must pass ADP/ACP testing. Safe harbor contributions are deemed to pass these tests. They provide minimum funding contributions for non-highly compensated employees which are 100% vested. There are two funding options: a matching contribution which is 100% of deferrals up to 3% of allocation compensation and 50% on the next 2% of allocation compensation, or a 3% safe harbor non-elective (profit sharing) to all eligible employees.

QNECs and QMACS are special contributions allowed in the plan document that are contributed to employees as a method of correcting testing failures. These contributions are 100% vested and follow specific formulas for correction. These types of contributions are discretionary and generally allow a highly compensated employee to retain contributions in the plan for testing failures.

The proposed regulations will allow plans to use forfeitures to fund QNECs and QMACs, including ADP safe harbor matching and non-elective contributions (fully vested sources- at the time the amounts are funded.

Since the regulations are proposed, they may be relied upon. This does not allow a retroactive application to the 2016 plan year; however, forfeitures can be applied to current 2017 funding such as matching contributions.

These changes bring a welcomed change to the use of forfeitures for safe harbor 401(k) and 403(b) plans. Administrators of 403(b) plans that utilize fully-vested funding options will have more viable options under this approach.

Kimberly Flett is Managing Director, National Practice Leader ERISA, STS Compensation and Benefits.

Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA or its members.