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Frequent 401(k) Audit Finding Series - Use of Forfeitures

Background

Forfeitures arise when an employee's employment terminates before fulfilling the length of service required to become fully vested in employer contributions.  The non-vested portion of the employee’s account is “forfeited” and placed in a suspense account that is used per the terms of the Plan document or adoption agreement.

Observations

Current law allows Sponsors to utilize forfeitures in one, or a combination, of the following ways:

1. To offset allowable expenses
2. To reduce future employer contributions
3. To be reallocated as additional employer contributions

Failures

During 401(k) audits, one of the operational failures we encounter are forfeitures that are not used in accordance with the method selected in the Plan’s adoption agreement.  These failures can be significant and cause corrective action that spread across many years.

Corrective action

Insignificant failures, which are corrected within two years, are self-corrected in the manner that the forfeitures should have used to begin with.  For significant failures, or corrections that extend beyond two years, the Plan should enter a formal Voluntary Correction Program as outlined by the IRS Employee Plans Compliance Resolution System. 

When the Sponsor elected to reallocate forfeitures as additional employer contributions but failed to do so, the corrective action requires annual calculations for each year the failure occured.  These calculations are necessary to allocate the forfeitures as of each year-end to the respective participants who were eligible to receive during the period.  These annual retro-active allocations will likely cause further issues as many of the individuals owed a portion of the allocation may no longer be employed by the Sponsor and many may have initiated final distributions.  This results in an additional step of having to track down former employees to pay them the corrective allocations.