/>iThe US Treasury Department recently issued proposed regulations that make it easier for sponsors of 401(k) plans to use assets from the plans’ forfeiture accounts to correct nondiscrimination testing failures and other plan failures.
The Internal Revenue Code (Code) and applicable regulations provide nondiscrimination requirements that apply to 401(k) plans. Among those requirements are the actual deferral percentage (ADP) and actual contribution percentage (ACP) tests, which limit the allowable disparity between contributions made to a plan on behalf of highly compensated employees and those made on behalf of non–highly compensated employees. For these purposes, contributions include employee pre-tax and after-tax contributions and employer matching contributions, as well as Qualified Matching Contributions (QMACs) and Qualified Nonelective Contributions (QNECs). Plan sponsors often contribute QMACs and QNECs on behalf of non–highly compensated employees as a way to correct for ADP or ACP testing failures. QMACs and QNECs can also be used to fund certain contributions that correct mistakes in a plan’s operation or to fund ADP and ACP safe harbor contributions.
Applicable regulations define QMACs and QNECs as matching contributions and employer contributions (other than elective or matching contributions) that are fully vested and are subject to certain distribution restrictions when they are contributed to the plan. The requirement to be fully vested “when contributed to the plan” has been interpreted to mean that QMACs and QNECs cannot be paid from a plan’s forfeiture account. This is because forfeited contributions are amounts that were subject to a vesting schedule when first contributed to the plan and were forfeited when a participant terminated employment before those contributions became fully vested.
Earlier this year, the Treasury Department proposed an amendment to the regulations under Code Sections 401(k) and 401(m) to provide that amounts used to fund QMACs and QNECs must be fully vested when allocated to participant accounts, rather than when they are first contributed to a plan as currently required. This would have the practical effect of allowing plan sponsors to use forfeitures to fund QMACs and QNECs.
As was already mentioned, one of the important consequences of this change is that it permits plan sponsors to use forfeitures to fund participant accounts when correcting certain operational failures in accordance with Revenue Procedure 2016-51, Employee Plans Compliance Resolution System (EPCRS). For example, suppose a participant’s deferral election increase from 4% to 8% of eligible compensation was not properly implemented and the participant’s deferral rate of 4% continued for six months before the error was identified. EPCRS describes this error as an “Employee Elective Deferral Failure” and prescribes a number of steps to fix the error, including the contribution of a QNEC equal to a percentage of the missed deferral opportunity, adjusted for earnings. Before the proposed regulations, the plan sponsor was required to make a contribution to the plan from company assets to fund the QNEC. Under the proposed regulations, the plan’s existing forfeiture account—money that is already in the plan’s trust—can be used to correct the operational failure, making it easier for plan sponsors to fix these types of administrative mistakes.
The regulations are proposed to apply to taxable years beginning on or after the date of their publication as final regulations. However, plan sponsors may rely on these proposed regulations for periods prior to this proposed applicability date. In order to do so, plan sponsors should confirm that their plans allow forfeitures to be used to fund employer corrective contributions and otherwise do not limit the use of forfeitures to fund QMACs or QNECs. If a plan document does not currently permit forfeitures to fund corrective contributions or limits the use of forfeitures to corrective contributions that are not QNECs or QMACs, the plan should be amended to permit these uses.
