The IRS has not yet finalized its long-awaited regulations on retirement plan forfeitures, but that doesn’t mean plan sponsors can afford to take a wait-and-see approach.
In fact, the IRS has made it clear that sponsors may rely on the proposed regulations issued in 2023 (REG-122286-18) for periods preceding the applicability date. Because reliance is expressly permitted, a sponsor may choose to operate consistently with the proposal, and auditors evaluate forfeiture use against the plan document.
For plan sponsors preparing for 2025 and 2026 audits, understanding the current expectations around forfeiture accounts is becoming increasingly important.
A Quick Refresher on Forfeitures
Forfeitures generally arise when participants leave an employer before becoming fully vested in employer contributions. Those nonvested amounts are typically held in a forfeiture account and later used for purposes permitted under the plan, such as reducing employer contributions or paying plan expenses.
Historically, one of the biggest questions surrounding forfeitures has been timing. How long can forfeiture balances sit unused before they become a compliance concern?
While prior IRS guidance addressed the issue informally, the proposed regulations provide the clearest direction to date.
What the Proposed IRS Forfeiture Regulations Would Require
The proposed regulations reinforce the expectation that forfeitures should be used no later than 12 months after the close of the plan year in which they were incurred.
As an example, a calendar-year plan with forfeitures incurred during the 2025 plan year would need to use those amounts by December 31, 2026. For a plan with a non-calendar plan year, the 12-month clock runs from the close of that plan year instead.
The proposal includes a transition rule: forfeitures incurred in any plan year beginning before January 1, 2024, are treated as though incurred in the first plan year beginning on or after January 1, 2024. For a calendar-year plan, pre-2024 forfeitures are treated as 2024 forfeitures and, for a sponsor relying on the proposal, would need to be used by December 31, 2025.
How the Plan Document Controls the Permitted Use
The proposal permits forfeitures to be used for one or more of exactly three purposes: to pay plan administrative expenses; to reduce employer contributions under the plan; or to increase benefits in other participants’ accounts in accordance with plan terms. The plan document determines which permitted use or uses are available. A plan may authorize only a single use, but if forfeitures in a year exceed what that one use can absorb within the deadline, the plan can incur an operational qualification failure; authorizing more than one permitted use can help avoid this result.
What This Means for Audits
For sponsors undergoing employee benefit plan audits in 2025 and 2026, one trend is becoming increasingly common: greater scrutiny of forfeiture accounts that have been carrying large balances for extended periods.
Large, longstanding forfeiture suspense accounts can raise questions about whether plan assets are being administered in accordance with plan provisions and IRS expectations. They may also suggest that forfeitures are not being used in a timely manner.
Even though the proposed regulations are not yet final, many auditors are considering them when assessing plan operations because they represent the IRS’s current direction and because the agency has specifically permitted reliance on the guidance.
Why Sponsors Should Take Action Now
Waiting for final regulations may seem reasonable, but many plan sponsors could benefit from reviewing their forfeiture balances sooner rather than later.
A proactive review can help organizations:
- Identify forfeiture amounts that have accumulated over multiple years
- Determine whether forfeitures are being used consistently with plan provisions
- Review the plan document’s forfeiture terms, including whether it permits a single use or multiple uses
- Evaluate administrative processes for tracking and applying forfeitures
- Address potential compliance concerns before they become audit findings
For plans with significant forfeiture balances, the review process may also involve discussions with legal counsel, TPAs, and auditors to determine the most appropriate path forward.
Next Steps
The proposed forfeiture regulations remain just that, proposed. However, the practical reality is that many retirement plan professionals are already advising sponsors to operate in accordance with them.
Because the IRS has expressly allowed reliance on the proposed regulations and because large forfeiture suspense accounts continue to attract scrutiny, plan sponsors should view this as an opportunity to assess their current practices rather than wait for final rules to arrive.
Taking a closer look now can help reduce risk, support smoother audits, and position retirement plans for compliance regardless of when the final regulations are ultimately issued.
If you have any questions, we are here to help. Please do not hesitate to reach out to discuss your specific situation.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.
