Forfeiture Suspense Accounts
Rev. 06/21/10; E-mail Alert 2010-9

In its Spring 2010 issue of Retirement News for Employers, the IRS stressed the importance of timely allocating forfeitures within defined contribution plans.  Also included was the recommended correction method for when a plan sponsor fails to allocate forfeitures to participants on time.  This article will discuss the timeframe for allocating forfeitures and the appropriate corrections for when a failure occurs.

Plans that use forfeitures to pay expenses or reduce employer contributions should have plan language and administrative procedures in place to ensure the timely use of forfeitures in the year in which they occurred.

This type of error is eligible for correction under the IRS’ Employee Plans Compliance Resolution System (EPCRS).  Section 6 of Rev. Proc. 2008-50 details the availability for using the Self Correction Program (SCP) or the Voluntary Correction Program (VCP). 

For more on this subject come to either our Retirement Plan Insights or Practitioner seminars.

Below for Reference is from the IRS Web page
http://www.irs.gov/retirement/article/0,,id=223590,00.html

The Issue
Many defined contribution plans require participants to complete a period of service before becoming fully vested in matching or nonelective employer contributions. If a participant leaves a company before completing the service required for full vesting, his or her non-vested account may be forfeited. Some plan administrators place these forfeited amounts into a plan suspense account, allowing them to accumulate over several years. The Internal Revenue Code does not allow this practice.

Find the Mistake
Forfeitures must be used or allocated in the plan year incurred. The Code does not authorize forfeiture suspense accounts to hold unallocated monies beyond the plan year in which they arise. Revenue Ruling 80-155 states that a defined contribution plan will not be qualified unless all funds are allocated to participants’ accounts in accordance with a definite formula defined in the plan. This would preclude a plan from carrying over plan forfeitures to subsequent plan years, as doing so would defy the rule requiring all monies in a defined contribution plan to be allocated annually to plan participants. Revenue Ruling 84-156 states that forfeitures may be used to pay for a plan’s administrative expenses and/or to reduce employer contributions. Treasury Regulations §1.401-7(a) notes that forfeitures must be used as soon as possible to reduce employer contributions.

The plan document’s terms should have provisions detailing how and when a plan will exhaust plan forfeitures. A plan’s failure to use forfeitures in a timely manner denies plan participants additional benefits or reduced plan expenses.
Common causes for this error include:

• The plan’s sponsor and/or third party administrator fails to monitor the plan’s forfeiture account to ensure that forfeitures generated in that plan year are used according to the plan’s terms.
• The plan sponsor erroneously thinks that he or she has discretion over how and when forfeiture monies in the suspense account can be applied.
• Plan document terms are vague in describing how forfeitures are to be handled and results in the plan’s document and operation being inconsistent with the holdings in Revenue Rulings 80-155, 84-156 and the Code.

Fix the Mistake
Generally, this failure can be corrected by reallocating all forfeitures in the plan’s forfeiture suspense account to all plan participants who should have received them had the forfeitures been allocated on time. The plan sponsor should revise prior plan year allocation reports to reflect the forfeiture allocation and pay any amounts due to terminated participants. Depending on the plan terms or the facts and circumstances of a particular situation, it may be appropriate to take the non-current-year forfeitures and use them as employer contributions for the current plan year. Plan sponsors should apply the correction principles in Revenue Procedure 2008-50, section 6 when making correction.

Plan sponsors can correct this mistake using the Employee Plans Compliance Resolution System (EPCRS). Using the Self-Correction Program, the mistake must generally be fixed 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 must be used after this time. VCP must also be used if the plan document terms are defective and need to be corrected retroactively by a plan amendment.

Avoid the Mistake
Plan sponsors and third party administrators need to monitor plan forfeitures. If a suspense account is used, then they must ensure that all forfeitures for a plan year are promptly used according to the plan’s terms.

• No forfeitures in a suspense account should remain unallocated beyond the end of the plan year in which they occurred.
• No forfeiture should be carried into a subsequent plan year.
• For those plans that use forfeitures to reduce plan expenses or employer contributions, there should be plan language and administrative procedures to ensure that current year forfeitures will be used up promptly in the year in which they occurred or in appropriate situations no later than the immediately succeeding plan year.

REV. RUL. 80-155, 1980-1 C.B. 84
Valuation and allocation of trust assets.
A defined contribution plan does not qualify where trust earnings are allocated to participants, and the valuation of trust investments are made, at infrequent or irregular intervals or different valuation methods are used for different participants. However, a plan provision allowing interim valuations at the trustee's discretion in addition to a constant annual valuation will not disqualify a plan, provided the use of the interim valuations does not result in prohibited discrimination. Rev. Ruls. 70-125 and 71-27 superseded.

26 CFR 1.401-1: Qualified pension, profit-sharing, and stock bonus plans.
The purpose of this revenue Ruling is to restate the position in Rev. Rul. 70-125, 1970-1 C.B. 87, and Rev. Rul. 71-27, 1971-1 C.B. 121, in view of the Employee Retirement Income Security Act of 1974, Pub. L. 93-406, 1974-3 C.B. 1.

The issue in Rev. Rul. 70-125 is whether a defined contribution plan that contains a definite formula for crediting the employer's contributions to the participants’ accounts but with no specific provision for allocation of trust earnings to participants’ accounts or for the periodic valuation of trust investments is a qualified plan under section 401(a) of the Internal Revenue Code.

The issue in Rev. Rul. 71-27 is whether a plan provision allowing interim valuations in addition to an annual valuation will result in a plan's disqualification.
Section 414(i) of the Code states that a defined contribution plan is a plan that provides for an individual account for each participant and for benefits based solely on the amount contributed to the participant's account, and any income, expenses, gains and losses, and any forfeitures of acounts of other participants which may be allocated to such participant's account.

Section 1.401-1(b)(1)(ii) of the Income Tax Regulations states that a profit-sharing plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants and for distributing the funds accumulated under the plan. Section 1.401-1(b)(1)(iii) states that, for purposes of allocating and distributing the stock of the employer, a stock bonus plan is subject to the same requirements as a profit-sharing plan.
A pension plan of the money purchase type provides for fixed contributions that are not geared to profits. See section 1.401-1(b)(1)(i) of the regulations. Contributions under such a pension plan are accumulated under the plan and, along with the earnings thereon, distributed to participants in accordance with the terms of the plan.

Because profit-sharing, stock bonus and pension plans of the money purchase type (i.e., defined contribution plans) are required to provide for distributions in accordance with amounts stated or ascertainable and credited to participants, the funds under such a trust must be allocated to participants’ accounts in accordance with a definite formula (although certain exceptions are allowed, such as the use of a suspense account in accordance with the requirements of section 415 of the Code).

Furthermore, if the amounts to be allocated or distributed to a particular participant are to be ascertainable, such plans must provide for a valuation of investments held by the trust, at least once a year, on a specified inventory date, in accordance with a method consistently followed and uniformly applied. The fair market value on the inventory date is to be used for this purpose. The respective accounts of participants are to be adjusted in accordance with the valuation.

In the case of a plan in which trust earnings, unrealized changes in the value of trust investments, and losses realized on the sale of trust assets may be valued and allocated to participants’ accounts at infrequent or irregular intervals or different valuation methods may be used for different participants, the plan does not provide a definite formula for allocating and distributing the funds, as required by the regulations.

Accordingly, such a plan does not qualify under section 401(a) of the Code.
However, a plan provision allowing interim valuations at the trustee's discretion in addition to a consistent annual valuation does not disqualify the plan so long as the use of the interim valuations does not result in discrimination prohibited by section 401(a)(4) of the Code.
Rev. Ruls. 70-125 and 71-27 are superseded because the positions stated therein are restated under current law.

§ 1.401-7 Forfeitures Under A Qualified Pension Plan.
1.401-7(a) General Rules.
In the case of a trust forming a part of a qualified pension plan, the plan must expressly provide that forfeitures arising from severance of employment, death, or for any other reason, must not be applied to increase the benefits any employee would otherwise receive under the plan at any time prior to the termination of the plan or the complete discontinuance of employer contributions thereunder. The amounts so forfeited must be used as soon as possible to reduce the employer's contributions under the plan. However, a qualified pension plan may anticipate the effect of forfeitures in determining the costs under the plan. Furthermore, a qualified plan will not be disqualified merely because a determination of the amount of forfeitures under the plan is made only once during each taxable year of the employer.

1.401-7(b) Examples.
The rules of paragraph (a) of this section may be illustrated by the following examples:

Example (1)
The B Company Pension Trust forms a part of a pension plan which is funded by individual level annual premium annuity contracts. The plan requires ten years of service prior to obtaining a vested right to benefits under the plan. One of the company's employees resigns his position after two years of service. The insurance company paid to the trustees the cash surrender value of the contract--$750. The B Company must reduce its next contribution to the pension trust by this amount.

Example (2)
The C Corporation's trusteed pension plan has been in existence for 20 years. It is funded by individual contracts issued by an insurance company, and the premiums thereunder are paid annually. Under such plan, the annual premium accrued for the year 1966 is due and is paid on January 2, 1966, and on July 1 of the same year the plan is terminated due to the liquidation of the employer. Some forfeitures were incurred and collected by the trustee with respect to those participants whose employment terminated between January 2 and July 1. The plan provides that the amount of such forfeitures is to be applied to provide additional annuity benefits for the remaining employees covered by the plan. The pension plan of the C Corporation satisfies the provisions of section 401(a)(8). Although forfeitures are used to increase benefits in this case, this use of forfeitures is permissible since no further contributions will be made under the plan.

1.401-7(c) Effective Date.
This section applies to taxable years of a qualified plan commencing after September 30, 1963. However, a plan which is qualified on September 30, 1963, will not be disqualified merely because it does not expressly include the provisions prescribed by this section.
[T.D. 6675, 28 FR 10121, Sept. 17, 1963]

REV. RUL. 84-156, 1984-2 C.B. 97
ISSUE
Does a pension plan provision for use of forfeitures in the manner described below satisfy the requirements of section 401(a)(8) of the Internal Revenue Code?

FACTS
A corporation established a money purchase pension plan that provides for the contribution of a specified percentage of each employee's compensation. It also provides that forfeitures will be used to reduce reasonable administrative expenses with any excess to be used to reduce further employer contributions.

LAW AND ANALYSIS
Section 401(a)(8) of the Code provides that a trust forming part of a pension plan will not be qualified unless the plan provides that forfeitures must not be applied to increase the benefits any employee would otherwise receive under the plan.

Section 1.401-7(a) of the Income Tax Regulations requires that forfeitures arising from severance of employment, death, or for any other reason must be used as soon as possible to reduce the employer's contributions to the plan. However, in determining cost under a qualified pension plan, it is permissible to anticipate the effect of forfeitures.
Rev. Rul. 67-68, 1976-1 C.B. 86, states that provisions requiring that forfeitures be applied to reduce employers’ future contributions have the effect of precluding the use of forfeitures to increase benefits otherwise provided under the plan and are consistent with sectionof the Code.401(a)(8)

The use of forfeitures first to reduce administrative expenses which could have been made up for future contributions and then to reduce future contributions will not be considered inconsistent with the requirement of section 1.401-7(a) of the regulations that forfeitures be used as soon as possible to reduce employer contributions.

HOLDING
The plan provisions for use of forfeitures satisfies the requirements of section 401(a)(8) of the Code.