After many years of advocacy by the American Retirement Association’s Government Affairs Committee, the IRS has released final regulations allowing for the use of forfeitures to fund QNECs and QMACs.
In doing so, the IRS has corrected what the Government Affairs Committee believed to be an incorrect interpretation of the Internal Revenue Code (IRC). The final resolution of this issue should be welcomed by all ARA members.
How We Got Here
The 401(k) regulations we follow today are the result of a rewrite that was issued in 2004. Under those regulations (and their predecessor), there had never been any issue with using forfeitures as a funding source for qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs) that may be due under the terms of the plan. That all changed in 2011.
Heading into the second 6-year pre-approved plan restatement cycle, the IRS issued an updated Listing of Required Modifications (LRM) which reflects model language and other instructions on what is expected to be in next cycle of restatements. The new LRM contained a surprising new directive that “forfeitures may not be used as ADP Test Safe Harbor Contributions.” That directive was based on a strict reading of the 2004 regulation’s admonition that QNECs and QMACs “must satisfy the vesting requirements … when they are contributed to the plan.”
Pressing the Issue
ARA GAC immediately took issue with this interpretation as being contrary to clear wording in the IRC that requires QNECs and QMACs to be fully vested when allocated to a participant’s account rather than when first contributed to the plan. While the 401(k) regulation could be read that way, to do so would ignore the statutory language.
ARA GAC filed comment letters in May 2012 and July 2013 requesting that the IRS interpretation be rescinded as contrary to the law. This was also a regular agenda item at the annual meetings that ARA GAC has had with the IRS over the last few years. Those discussions were productive and although it took a long time, the IRS has now righted that wrong.
Based on GAC’s informal discussions with the IRS over the years, it became clear that an amendment of the 401(k) regulations would be necessary to clarify the issue. In January 2017, the IRS issued proposed regulations to amend the definition of QNECs and QMACs to provide that the fully vested mandate only applies when amounts are allocated to a participant’s account rather than when contributed to the plan. This is consistent with the statute and is essentially what ARA GAC had asked for from the start.
What’s Next
The final regulations are effective as of today, July 20. They make no substantive change to what was proposed 18 months ago. Since the proposed regulations permitted plan sponsors to rely on them in the interim, many plans have already adopted this change.
It is also important to remember that plan language must be updated to allow for this approach before implementing it operationally.
Craig Hoffman is General Counsel of the American Retirement Association.
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