February 2023 Compliance News Article

Proposed Forfeiture Regulations

The Internal Revenue Service (IRS) released proposed rules relating to the use of forfeitures in qualified retirement plans, including a new deadline for the use of forfeitures.

Clarification for Defined Benefit

The regulations for pension plan forfeitures established in 1963 and later updated in the Tax Reform Act of 1986 have become inconsistent with the minimum funding requirements established more recently. As a result, the proposed regulations will eliminate the rule to use forfeitures as soon as possible to better align with minimum funding requirements. The proposal also clarifies that forfeitures cannot be used to increase benefits prior to plan termination.

Defined Contribution Updates

Proposed regulations intend to clarify that forfeitures in defined contribution (DC) plans (including money purchase plans)must specify how forfeitures will be used. The alternatives include one or more of the following:

Pay plan expenses,
Reduce employer contributions under the plan, including restoration of inadvertent benefit overpayments, or
Increase benefits to other participants’ accounts according to plan terms.

Although the proposed regulations do not limit a plan from indicating only one purpose for forfeitures, there is a caution that a plan operational failure may result if forfeitures in a given year exceed the amount that may be used for that one purpose. For example, if forfeitures may only be used to pay plan expenses, but the forfeiture amount exceeds the amount of expenses, the plan would incur an operational qualification failure.

Additionally, the deadline to use forfeitures will be 12 months after the close of the plan year in which the forfeitures are incurred.

Effective Date and Comments

These changes are proposed to apply for plan years beginning on or after January 1, 2024. Taxpayers, however, may rely on these proposed regulations for periods preceding this date. A transition rule would allow forfeitures that have accumulated in any plan year that begins prior to January 1, 2024to be considered incurred in the first plan year that begins on or after January 1, 2024 and must be used within 12 months following the end of this plan year.

The IRS also welcomes comments received by May 30, 2023. Commenters are strongly encouraged to submit public comments electronically via the Federal eRulemaking Portal at www.regulations.gov. Comments must indicate IRS and REG-122286-18.

The subject matter in this communication is educational only and provided with the understanding that Principal^® is not rendering legal, accounting, investment or tax advice. You should consult with appropriate counsel, financial professionals or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

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