Monday, March 27, 2017

Proposed regulations allow use of forfeitures to make QNEC, QMAC, and safe harbor contributions

On January 18, 2017, the IRS issued proposed regulations making a change to the time by which qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs), including those made as 401(k) safe harbor contributions and those used to correct plan operations failures and nondiscrimination test failures, must be made. The change allows the use of plan forfeitures to fund such contributions.

Timing Is Everything
QNEC and QMAC contributions must be 100 percent vested and subject to distribution restrictions similar to elective deferrals. Until now, IRS regulations stated that those conditions were required to be met when QNECs and QMACs were contributed to a plan. In recent years, the IRS let it be known that it interpreted its regulation literally, preventing the use of forfeitures of employer contributions to make QNECs or QMACs because, at the time the forfeited contributions were originally made to the plan (e.g., as matching or profit sharing contributions), they were not 100 percent vested and did not meet the elective deferral distribution restrictions.

The IRS took this position despite the fact that if forfeitures were used to reduce QNECs or QMACs they would become fully vested and be subject to the elective deferral restrictions when they were contributed (allocated) to the accounts of participants under the plan. The IRS’ narrow interpretation resulted in many plan sponsors having to make additional plan contributions even though their plans contained forfeitures and allowed forfeitures to be used to reduce contributions. This result was the basis for many in the industry to advocate change.

The IRS responded with proposed regulations that impose the special distribution and vesting requirements at the time QNECs and QMACs are allocated to participants’ accounts, rather than when contributed to the plan.

Going Forward
Although the proposed regulations apply to taxable years beginning on or after the date they are issued as final regulations, the IRS is allowing plan sponsors to rely on the proposed regulations immediately. Plan sponsors wanting to use forfeitures to make QNEC or QMAC contributions— including 401(k) safe harbor contributions—must review their plan documents to make sure they

  • allow forfeitures to be used to reduce employer contributions, and 
  • do not contain language restricting the use of forfeitures to fund QNEC or QMAC contributions. 

Although the IRS’ change to the actual language in the proposed regulation is minor, the implications of its change are far-reaching and beneficial to plan sponsors, who can now make 401(k) safe harbor contributions and correct plan defects less expensively by using forfeitures instead of making additional plan contributions to achieve the same result.