On February 24, 2023, the IRS issued proposed regulations simplifying the use of forfeitures in qualified retirement plans. Catch up on this change with today’s #DYHAM. …(read more)

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Retirement Plan Forfeitures: What You Need to Know

Retirement plans can be a valuable tool for individuals to save for their future. These plans, such as 401(k) or pension plans, allow employees to contribute a portion of their income towards retirement, often with the added benefit of employer matching contributions. However, not all funds contributed to retirement plans are guaranteed to be received by the employee upon retirement. In some cases, these funds may be forfeited, leading to potential loss for the employee.

Retirement plan forfeitures occur when an employee leaves a company before becoming fully vested in their retirement account. Vesting is a term used to describe an employee’s right to receive all or a portion of the employer’s contributions made to a retirement plan. Usually, there is a vesting schedule that determines how quickly an employee becomes eligible to keep employer contributions. For example, a company may have a five-year graded vesting schedule, where an employee becomes 20% vested after one year of service and then earns an additional 20% each subsequent year until reaching full vesting at year five. If an employee leaves the company before completing the full vesting period, any non-vested employer contributions are considered forfeitures.

The most common reasons for retirement plan forfeitures are employees leaving a company voluntarily or being terminated. When an employee voluntarily leaves a company, they usually have the option to roll over their vested funds into an individual retirement account (IRA) or another qualified retirement plan, avoiding any forfeiture. However, if an employee is terminated or laid off before becoming fully vested, they may lose some or all of the employer contributions that were not vested at the time of termination. These forfeited funds then go back into the employer’s general retirement plan pool, potentially benefiting other employees.

It is important for employees to understand the vesting schedule of their retirement plan and the implications of leaving the company before becoming fully vested. Knowing the vesting rules can help individuals make informed decisions about their employment and retirement planning. Additionally, employees should be aware of any vesting cliff provisions, which can result in a complete loss of all employer contributions if an employee does not meet certain criteria, such as a minimum number of years of service.

In some cases, employers may offer a vesting schedule that allows for immediate vesting or accelerated vesting. Immediate vesting means that all employer contributions are fully vested from the moment they are made, granting the employee immediate ownership of those funds. Accelerated vesting allows an employee to become fully vested in a shorter time frame than the standard schedule, such as three years rather than five. These options can benefit employees by reducing the risk of future forfeitures.

Employers have several options for handling forfeitures within their retirement plans. The most common approach is to use forfeitures to offset plan expenses or to be used as a source for future employer contributions. Some employers may choose to reallocate forfeitures among active plan participants, providing a small increase in account balances for those who remain with the company. Ultimately, it is up to the plan sponsor to determine how forfeitures are utilized within the retirement plan.

In conclusion, retirement plan forfeitures occur when an employee leaves a company before becoming fully vested in their retirement account. It is crucial for employees to understand their plan’s vesting schedule and any potential consequences of leaving before full vesting. Employers should also be transparent about their plan’s vesting rules and options for handling forfeitures. By being informed and proactive, individuals can make the most of their retirement planning and ensure they receive the benefits they are entitled to upon retirement.