United States

IRS releases guidance on retirement plan matching contributions

TAX BLOG


The IRS issued proposed regulations under reg. section 1.401(k)-6 changing the definition of qualified matching contributions (QMACs) and qualified nonelective contributions (QNECs) applicable to 401(k) plans. The change allows employers more flexibility in using forfeitures inside the 401(k) plan to reduce future employer contributions. Although this is favorable to plan sponsors, it may be too little, too late.

Qualified retirement plans, including 401(k) plans, are subject to a number of requirements to remain qualified. Some of these requirements are nondiscrimination rules that prevent employers from favoring highly paid employees by allowing greater participation or providing greater benefits to that group.

To prove compliance with these nondiscrimination rules, plan administrators must complete various mathematical tests on plan information such as the eligible population of employees and contribution levels with respect to employees. Because 401(k) plans allow employees to contribute their own money to the plan, a feature most other retirement plans do not have, an additional compliance test applies to 401(k) plans that applies to the level of employee deferrals into the plan (the actual deferral percentage, or ADP, test).

Complying with these tests is burdensome and costly. Many employers choose to use a safe harbor 401(k) plan which is not required to do the ADP test. One way to satisfy the safe harbor rules is to provide matching contributions, QMACs or QNECs, to nonhighly compensated employees.

The current definition of QMACs and QNECs in reg. section 1.401(k)-6 requires the matching contributions to satisfy certain nonforfeitability and distribution provisions when the contributions are put into the plan. The nonforfeitability provisions essentially mean that the matching contributions must be fully vested at the time they are contributed; the employee has full rights with no risk of forfeiture on those matching contributions.

This prohibition on forfeitability is different from other employer contributions to qualified retirement plans that can be subject to vesting schedules. Therefore, if there are other employer contributions inside the plan that were not QMACs or QNECs, those contributions may be forfeited if a plan participant terminates employment before fully vesting in the contributions. The amounts forfeited are called forfeitures, and the plan document will include provisions on the use of those forfeited amounts.

One use is to reallocate those amounts to other employees who are still participating in the plan, and since many employers plan to contribute fixed amounts to the plan, this can reduce the additional contribution needed to get to a planned contribution level. The definition of QMAC and QNEC that referenced forfeitability at the time of contribution prevented these forfeitures from being used as QMACs or QNECs, so employers with safe harbor plans could not use forfeitures to reduce future matching contributions.

Under the proposed regulations, the IRS finally changed the definition of QMACs and QNECs to reference the time the contributions are allocated to participant accounts, rather than when they are contributed. Essentially this means that forfeitures that did not meet the definition when they were contributed to the plan (because by definition, to be forfeited, they were not nonforfeitable) can be characterized as nonforfeitable inside the plan before they are reallocated to other employees, and then they will qualify as QMACs or QNECs.

The guidance is most applicable to employers that make a discretionary contribution in addition to their safe harbor matching contribution in a 401(k) plan. This is because the definitions of QMAC and QNEC apply to 401(k) plans and safe harbor contributions have always had to be nonforfeitable at the time of contribution. Therefore, plans that have operated as safe harbor plans for several years likely do not contain any amounts that could potentially be forfeited. The only forfeitable amounts are employer contributions outside of safe harbor contributions.

Many employers adopted safe harbor provisions long enough ago that any employer contributions inside the plan that were made before the plan was a safe harbor plan are either fully vested or they have previously been forfeited and already used for a different purpose. Therefore, while employers are able to rely on the proposed regulations now to use forfeitures to reduce future safe harbor matching contributions, it may not be as useful as if the IRS had provided this guidance many years ago when many more plans had large amounts of forfeitures inside them.


Anne Bushman

Senior Manager

Anne advises companies on various executive compensation, employee stock ownership and employee benefits matters affecting closely-held businesses. Reach her at anne.bushman@rsmus.com.

Areas of focus: Washington National TaxCompensation & BenefitsTax Reform