IRS Allows 401k Plan Safe Harbor and ADP/ACP Corrective Contributions to be Funded from Forfeitures

Compensation & Benefits Alert | 02.27.17

We are pleased to bring you some good news for 401(k) plans from the IRS.

The IRS just issued a proposed regulation that allows safe harbor contributions to a 401(k) plan, or employer contributions used to correct a failed ADP or ACP test, to be funded from forfeitures. The proposed regulations provide that they can be relied upon immediately and that if the final regulations are more restrictive, they will not be applied retroactively.

Current Rule
Qualified nonelective contributions ("QNECs") and qualified matching contributions ("QMACs") can be used to make safe harbor nonelective or matching contributions to a 401(k) plan, or to correct a failed ADP or ACP test. These QNECs and QMACs must meet certain distribution restrictions and be fully vested. Under the IRS's current regulations, they must be fully vested when contributed to the plan. Because of the vesting at contribution requirement, they cannot be funded from forfeitures, since forfeitures initially were subject to a vesting schedule before being forfeited. The fact that forfeitures used to fund QNECs and QMACs become fully vested as soon as they are deposited into participants' accounts has not deterred the IRS from holding fast to this very controversial position – until now.

The Proposal
Under the proposed regulation, the requirement that QNECs and QMACs be fully vested when contributed to the plan is changed to a requirement that they be fully vested when allocated to participants' accounts. Problem solved.

Effective Date
The regulations are proposed to apply to plan years beginning on or after the date the regulations are finalized. However, as stated above, the regulations provide that they can be relied upon now and that if the final regulations are more restrictive, they will not be applied retroactively.

After this proposed regulation was published, the Trump administration issued an executive order requiring that for every new regulation implemented by federal agencies, two existing regulations must be cut. There are still many questions around what this really means and how it will be applied. However, since the Trump administration's concerns are about the cost of regulations to the economy and to business, this proposed regulation, which is employer-friendly and a simplification, could receive a positive response from the current administration.