It is not uncommon for 401(k) plans to include both a safe harbor contribution (matching or nonelective) and a profit sharing component. The safe harbor contributions must generally be immediately vested, while the profit sharing contribution may be subject to a vesting schedule of up to 6 years. With this type of design, forfeitures of former employees' non-vested profit sharing balances are sometimes used to offset other company contributions.
At the IRS Q&A panel at last week's 2010 ASPPA Annual Conference, the ability to use forfeitures to offset safe harbor contributions was thrown into question. IRS representatives referred to a 2006 Alert Guideline used by field agents when they audit plans.
The guideline indicates that Qualified Nonelective Contributions (QNECs) and Qualified Matching Contributions (QMACs) must be fully vested when contributed to the plan. Forfeitures, by their nature, result from non-vested contributions, so they are not fully vested at the time of contribution and cannot be used to fund QNECs or QMACs. Since regulations describe safe harbor matching contributions as QMACs and safe harbor nonelective contributions as QNECs, it follows that forfeitures cannot be used to fund these safe harbor contributions.
What Does This Mean For Plan Sponsors?
This interpretation has several potential ramifications for sponsors of safe harbor 401(k) plans. First, employers would be required to directly fund the entire safe harbor contribution amount.
Second, and perhaps more important, sponsors would need to monitor how forfeitures are used. Regulations generally require that forfeitures be used by the end of the year in which they occur. If they are not used to pay eligible plan expenses, they must be used to fund plan contributions. Since forfeitures cannot be used to fund safe harbor contributions, they must be allocated as additional matching or profit sharing contributions. For plans that are top-heavy, this allocation could trigger additional contribution obligations.
What Should I Do?
The comments from the IRS do not represent "official" guidance, and one of the panelists acknowledged that there are differences of opinion on this point within the IRS. Until further guidance provides clarification, the conservative approach is to avoid using forfeitures to fund safe harbor contributions.
Please contact us if you would like to discuss how this interpretation impacts your plan.
