Failure to Timely Allocate Forfeitures

by: Chadron J. Patton

Sponsors of 401(k) plans often fail to timely use or allocate forfeitures, thereby potentially disqualifying the plan. Recent IRS audits have revealed a renewed focus on the proper use of forfeitures – making compliance a top priority for plan sponsors.

Forfeitures are generally created when a participant leaves employment before completing the period of service needed to become fully vested in matching or other employer contributions. The non-vested portion of the participant’s account may then be forfeited. (In practice, many plans specify that the forfeiture occurs only after the participant has incurred five consecutive oneyear breaks in service.) Some plan sponsors or third party administrators (TPAs) then place the forfeited amounts into a plan’s suspense account, allowing the forfeitures to accumulate over a period of several years. This practice is impermissible.

The IRS requires that forfeitures be used or allocated for the plan year in which they arise or, in appropriate circumstances, the following plan year. Forfeitures may be used 5 to (1) pay a plan’s reasonable administrative expenses, (2) reduce employer contributions, (3) restore previously forfeited participant accounts, or (4) provide additional contributions to participants. The plan document must clearly define how and when forfeitures will be used. (Note: The IRS has recently taken the position that forfeitures cannot be used to fund 401(k) safe harbor contributions, because those contributions must be 100% vested when made to the plan. Future guidance is expected on this issue, however.)

Among the most common reasons for failing to timely allocate forfeitures are the following:

  • A plan sponsor or TPA fails to monitor the plan's forfeiture account to ensure that forfeitures generated during a plan year are used according to the plan's terms.
  • A plan sponsor and TPA both assume that the other party will be taking care of the forfeitures - and neither does so.
  • A plan sponsor erroneously assumes that it has discretion over how and when forfeitures held in a suspense account are to be applied.
  • A plan's terms are vague in describing how forfeitures are to be handled.
  • A plan sponsor elects not to make a discretionary contribution for a plan year and, because there are no contributions to offset with forfeited amounts, the sponsor fails to allocate the forfeitures.
  •  A plan sponsor pays administrative expenses directly or through revenue sharing, without thinking to use forfeitures to pay those expenses.

This common plan mistake may be corrected by reallocating all forfeitures in the plan’s forfeiture suspense account to any participants who should have received them had the forfeitures been allocated on a timely basis. Depending on the plan’s terms, or on the facts and circumstances of a particular situation, it may also be appropriate to apply forfeitures from prior years as an employer contribution for the current year.

Plan sponsors may correct this mistake under the IRS’s Employee Plans Compliance Resolution System (EPCRS). Under the EPCRS’s Self-Correction Program, the mistake must generally be corrected within two years following the close of the plan year in which it occurred (unless the failure can be classified as insignificant). The Voluntary Correction Program (VCP) must then be used after this two-year period. VCP must also be used if the plan’s terms are defective and must be retroactively corrected through a plan amendment.

Finally, here are some suggestions for plan sponsors looking to avoid this common plan mistake:

  • Review your plan document to ensure that there are clear procedures in place for the timing and use of forfeitures - and follow those procedures. If there are no procedures, or if they are vague, amend the plan document to add or clarify them.
  • Review the forfeiture suspense account at least annually to verify that forfeitures are actually being used or allocated.
  • Communicate with your TPA or record keeper to avoid any uncertainty as to whose responsibility it is to handle forfeitures.

by 6d-destani

HIGHLIGHTS OF THE PATIENT-CENTERED OUTCOMES / COMPARATIVE EFFECTIVENESS FEE

Important:  these highlights describe the rules based on the actual law and proposed regulations.  Most likely, therefore, the rules will take effect largely as described here, but some of the details may change.

  • The fee applies from 2012 to 2019, based on plan/policy years ending on or after Oct. 1, 2012, and before Oct. 1, 2019
  • The fee is due by July 31 of the year following the calendar year in which the plan/policy year ended
    • The first fee is due July 31, 2013, for calendar year plans and for those on October, November and December plan years
    • The first fee is not due until July 31, 2014, for those with plan years that start February through September.
  • The fee will be calculated and paid by:
    • The insurer for fully insured plans (although the fee likely will be passed on to the plan)
    • The plan sponsor of self-funded plans
      • This includes health reimbursement arrangements (HRAs)
      • Third-party administrator (TPA) may assist with calculation, but plan sponsor must file
      • If multiple employers participate in the plan, each must file separately unless the plan document designates one as the plan sponsor
  • The fee is based on covered lives (i.e., employees, retirees and dependent spouses and children)
    • May exclude employees/dependents residing outside U.S.
    • May exclude dependents, and only count the employee/retiree, when counting for an HRA
  • For the first year, the fee is $1 per covered life during the plan/policy year
  • For the second year, the fee is $2 per covered life during the year
  • For the third through seventh years, the fee is $2, adjusted for medical inflation, per covered life during the year
  • Applies to private, government, not-for-profit and church employers
  • Applies to grandfathered plans
  • "Group health coverage" includes:
    • Medical plans
    • Retiree only plans
    • HRAs
  •  "Group health coverage" does not include:
    • Stand-alone dental and vision (stand-alone means these benefits are elected separately from medical and have discrete premiums)
    • Life insurance
    • Short- and long-term disability and accident insurance
    • Long-term care
    • Health flexible spending accounts to which only employee contributions are made
    • Health savings accounts
    • Hospital indemnity or specified illness coverage
    • Employee assistance programs and wellness programs that do not provide significant medical care or treatment
    • Stop loss coverage
  • Several options have been proposed for calculating the fee:
    • Actual count method -- count the covered lives on each day of the year, and average the result
    • Snapshot method -- determine the number of covered lives on the same day of each quarter or month, and average the result
      • Could multiply the employee/retiree count by 2.35 to approximate the number of covered dependents rather than actually counting them
    • 5500 method - determine the number of participants at the beginning and end of year as reported on the 5500
      • If dependents are covered, add the participant count for the start and the end of the plan year
      • If dependents are not covered, add the participant count for the start and the end of the plan year and average the result (this method cannot be used by insurers)
  • If there are multiple self-funded plans (e.g., self-funded medical and HRA) with the same plan year, only one fee would apply to a covered life
  • If there are both fully insured and self-funded plans (e.g. insured medical and a self-funded HRA), a fee would apply to each plan -- the insurer would pay the fee on the insured coverage and the plan sponsor would pay the fee on the HRA
  • Plan sponsor reporting and paying the fee would be done electronically on IRS Form 720 each July 31
    • This would be an annual filing, even though form 720 is generally filed quarterly

Action Steps:

  • Insured plans may want to:
    • Ask their carrier if/when this fee will be reflected in rates
    • Include the anticipated fee in their budget
  • Self-funded plans may want to:
    • Include the anticipated fee in their budget
    • Review the likely calculation methods, determine which is best for their situation and close any data gaps
    • Verify there is a named plan sponsor if more than one employer participates in the plan, and if a plan sponsor has not been named, amend the plan to name a plan sponsor before the first fee is due

Note:  PPACA created a private, non-profit corporation called the Patient-Centered Outcomes Research Institute.  The Institute's job is to research the comparative effectiveness of different types of treatment for certain diseases, and to share its findings with the public and the medical community.  The goal is to improve quality of treatment and reduce unnecessary spending.  This fee is to support this research.

Reminder:  These highlights describe the rules based on proposed regulations. Some of this may change.

by 6d-destani