One of the most misinterpreted and misused features of a defined contribution plan is the forfeiture account.  Forfeiture accounts can benefit not only the plan, but also the plan sponsor.  Before we explain how forfeiture accounts can be beneficial, we first have to understand what a forfeiture account is.

What is a Forfeiture Account?

A forfeiture account is comprised of participants’ unvested employer contributions.  Usually a plan has a vesting schedule for any employer discretionary matching or discretionary profit sharing contributions made to employees.  If a participant distributes his or her balance from the plan before all employer contributions are vested, the unvested portion is retained in the plan (not distributed to the participant) under the forfeiture account.  Over a given year, many participants may elect to withdraw their balances from the plan which could greatly increase the forfeiture account if there are any unvested employer contributions.

It is important to understand that even though the forfeiture account is comprised of employer contributions made into the plan, the forfeiture account is a plan asset and cannot be given back to the employer.   A plan sponsor must read the plan document to identify how the plan can use the forfeiture account.  The most common ways forfeiture accounts are used are to pay plan expenses and to reduce employer contributions.  Again, the plan document will specify exactly how forfeitures can be used but most of the prototype plan documents include the two ways just mentioned.

Another important rule about forfeiture accounts, and one that many plan sponsors do not adhere to, is that the forfeitures should be used in the year they occur (i.e., the forfeiture account should be zero at the end of every year).  One exception to this rule, if your plan document includes this option, is to allow current year forfeitures to be used to reduce next year’s employer contribution requirements.  This is beneficial for a plan that funds its employer contribution requirements before it knows how much forfeitures it has at year end.

Forfeitures can be very beneficial both the plan and the plan sponsor.  It is important to remember that your plan document will dictate how forfeitures may be used and that the plan sponsor should use forfeitures in the year they occur.  If you have any questions regarding your forfeiture account or plan in general, please contact Jim Pellino at [email protected] or 312.670.6263.