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Understanding the 2024 Transition Rule for Forfeitures in DC Plans

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“What is the new transition rule for 2024 for applying accumulated forfeitures in defined contribution (DC) plans?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor in Colorado is representative of a common inquiry related to plan forfeitures.

Highlights of the Discussion

The 2024 transition rule allows sponsors of DC plans to treat forfeitures accumulated from previous plan years as if they were 2024 plan year forfeitures and use them by the end of the 2025 plan year. Here’s some background information.

On February 27, 2023, the IRS issued proposed regulations for using forfeitures in tax-qualified retirement plans (REG–122286–18). The proposed regulations extend the deadline by which plans must use forfeitures to the end of the plan year after the plan year in which the forfeitures occurred (e.g., end of the 2025 plan year to use 2024 forfeitures). Prior informal guidance from the IRS provided that forfeitures must be used or allocated in the plan year that they were incurred. Publication 4278 (Rev. 5-2010) (irs.gov). Importantly, the proposed regulations provide a transition rule that extends the deadline for using forfeitures accumulated in a plan year before 2024 in DC plans until the end of the 2025 plan year.  The proposed regulations may be relied on until the final regulations are issued.

What Are Forfeitures in Defined Contribution Plans?

Employer contributions such as profit-sharing (non-elective) contributions and matching contributions to a defined contribution plan may be subject to a vesting schedule. The partially vested account balances of participants who terminate employment are often the source of forfeitures. That is because the non-vested portion of employer contributions are forfeited on the earlier of the date that an employee: (1) terminates employment and receives a distribution of their vested portion of employer contributions; or (2) works less than five consecutive plan years and incurs five consecutive breaks in service. In addition, excess matching contributions allocated to non-vested highly compensated employees in 401(k) plans that fail actual contribution percentage (ACP) testing may be forfeited in order to pass the ACP test.

Further, after searching for “lost” participants, if the plan disburses their vested account balances  according to the plan document (e.g., IRA rollover, escheatment, etc.,), the non-vested portion would be forfeited. Before determining whether a participant is lost and forfeiting their non-vested account balance, a plan fiduciary should take all appropriate steps to locate missing participants. (See Missing Participants or Beneficiaries | Internal Revenue Service (irs.gov) and Missing Participants Guidance | U.S. Department of Labor (dol.gov) for further guidance on these steps).

Permitted Uses of Forfeitures In Defined Contribution Plans

Depending on plan document provisions, accumulated forfeitures can be used to

  1. Pay certain plan expenses;
  2. Reduce employer contributions; or
  3. Be allocated as additional employer contributions.

2024 Transition Rule Relief

Fortunately, the proposed regulations recognize that forfeitures accumulated over the years may not have been used on a timely basis. Accordingly, the proposed regulations provide a special transition rule that gives plan sponsors additional time to use accumulated forfeitures.  Specifically, forfeitures accumulated prior to January 1, 2024, will be treated as if they were first forfeited in the 2024 plan year. Since the deadline for using forfeitures is 12 months after the end of the first plan year in which the forfeiture occurred, this transition rule means that plan sponsors have until the end of the 2025 plan year to use all accumulated forfeitures in accordance with the terms of their plan documents.

Conclusion

The transition rule under the proposed regulations provides plan sponsors with an opportunity to use the 2024 plan year to “clean the slate” and treat forfeitures occurring before the 2024 plan year as first occurring in the 2024 plan year. Plan sponsors should ensure that these accumulated forfeitures are applied within the transition period that closes at the end of the 2025 plan year. The transition rule also presents an opportunity for plan sponsors to review their administrative procedures to help ensure plan operations comply with the requirement that forfeitures be used no later than the end of the plan year after the plan year in which the forfeitures occurred. Depending on how forfeitures may be used under the terms of the plan, using accumulated forfeitures could reduce the cost of future employer contributions, and/or defray reasonable plan expenses. This case is covered on our YouTube channel Understanding the 2024 Transition Rule for Forfeitures in DC Plans.

 

 

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Defining an Employee vs. Independent Contractor—New DOL Guidelines

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Do the final Department of Labor regulations defining employee vs. independent contractor affect who can participate in retirement plans?

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor in New Mexico is representative of a common inquiry related to the definition of employee. 

Highlights of Discussion

The answer is … they may. Whether a worker is an employee or independent contractor is an important determination that has several implications for employers, including for labor standards, tax purposes and retirement plan coverage. When it comes to plan coverage purposes, ERISA imposes a two-part test that an individual must meet to qualify as a plan participant: [1]

  1. First, the individual must be an employee.
  2. Second, the individual must be eligible to receive benefits under the plan according to the terms of the plan document.

For the first prong, we need a definition of employee. The second prong underscores the importance of reviewing plan document language to see how the terms “employee” and “participant” are defined.

The Department of Labor (DOL) has issued new regulations, effective March 11, 2024, addressing how to analyze whether a worker is an employee or an independent contractor under the Fair Labor Standards Act (FLSA). It also updated its Fact Sheet 13: Employment Relationship Under the Fair Labor Standards Act (FLSA).

While the final rule does not directly apply to ERISA, historically, the industry has looked to the FLSA, court rulings and informal guidance from the DOL and IRS to help define who is an independent contractor (and not an employee). The U.S. Supreme Court on several occasions has ruled that there is no single rule or test for determining whether an individual is an independent contractor or an employee for purposes of the FLSA. The Court has held that it is the total activity or situation that controls. Among the factors which the Court has considered significant are

  • The extent to which the services rendered are an integral part of the principal’s business.
  • The permanency of the relationship.
  • The amount of the alleged contractor’s investment in facilities and equipment.
  • The nature and degree of control by the principal.
  • The alleged contractor’s opportunities for profit and loss.
  • The amount of initiative, judgment, or foresight in open market competition with others required for the success of the claimed independent contractor.
  • The degree of independent business organization and operation.

Under the new FLSA standard, which is specific to FLSA purposes, including equitable wages, the fair treatment of employees, child labor laws, etc., whether a worker is an employee or an independent contractor is determined by applying a six-part “economic realities” test.

The six factors are

  1. The opportunity a worker might have to affect profit or loss;
  2. The financial stake and nature of any resources a worker has invested in the work;
  3. The degree of permanence of the work relationship;
  4. The degree of control an employer has over the person’s work;
  5. Whether the work the person does is essential to the employer’s business;
  6. A factor regarding the worker’s skill and initiative.

Employers must look at the entire working relationship to decide whether a worker is an employee or an independent contractor. The final rule provides detailed guidance regarding the application of each of these six factors. No factor or set of factors among this list of six has a predetermined weight, and additional factors may be relevant as well.

The IRS, for tax purposes, has a separate “employee” standard. In the past, the IRS applied a 20-part test, but it has since reduced it to a three-part test to determine employee or independent contractor status:

The three factors are

  1. Financial control
  2. Behavioral control
  3. The nature of the working relationship

The IRS has some helpful online information as well on determining worker status at Independent Contractor (Self-Employed) or Employee?  For more certainty, a person or entity can ask the IRS to make a formal determination on a worker’s status by filing IRS Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The filing takes at least six months to process.

If it can be summarized, the determination of whether a person who provides services to a business is considered an employee or independent contractor is based on the degree of “control or direction” provided by the business to the worker and is dependent upon the facts and circumstances of each case.  Generally, an individual is an independent contractor if the business for which he/she performs services does not control the means or methods used by the worker to accomplish the promised result. It is important for the business owner to look at the entire relationship with the worker, consider the degree of his or her right to direct and control the worker’s actions and, finally, to document each of the factors the business owner uses to arrive at the determination.

Conclusion

Determining whether a worker is an employee or independent contractor particularly for retirement plan coverage purposes can be tricky. The DOL has a new FLSA employee standard. There’s also the IRS definition of employee for tax purposes and Supreme Court rulings. All three of these standards may impact whether a worker is an employee that should be covered under an employer-sponsored retirement plan. Sponsors and their legal advisors should look to the plan document for guidance and document the determination process. This case is covered on our YouTube channel Defining an Employee vs. Independent Contractor—New DOL Guidelines.

[1] Casey v. Atlantic Richfield et al., 2000 U.S. Dist. Lexis 6836 (C.D. Cal., March 29, 2000).

 

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RFP Every Three?

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“I’ve heard contradictory arguments regarding request for proposals (RFPs). Should my plan sponsor clients solicit RFPs on a regular basis?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor is representative of a common inquiry related to mergers and acquisitions.

A recent call with a senior financial advisor from Texas is representative of a common inquiry involving plan sponsors and service providers.  The advisor asked: “I’ve heard contradictory arguments regarding request for proposals (RFPs). Should my plan sponsor clients solicit RFPs on a regular basis?”

Highlights of Discussion

While the DOL may not formally require plan sponsors to regularly request RFPs from plan service providers, the agency does presume “… plans normally conduct requests for proposal (RFPs) from service providers at least once every three to five years … ” in anticipation of changes to fee and service disclosures.[1] In fact, the DOL has stated, “… in hiring any plan service provider, a fiduciary may want to survey a number of potential providers, asking for the same information and providing the same requirements. By doing so, a fiduciary can document the process and make a meaningful comparison and selection.”[2]

Court cases have provided more support for including a regular RFP process in plan governance. For example, in Ramos v. Banner Health, 461 F. Supp. 3d 1067 (D. Colo. 2020), the court considered it was “…  significant that the plan fiduciaries did not issue an RFP on recordkeeping fees for over 20 years after engaging the recordkeeper.” The court assessed damages of $1.6 million. Similarly, the appellate court in George v Kraft Foods Global Inc., No. 10-1469, WL 1345463 (7th Cir. Apr. 11, 2011) held that plan fiduciaries who did not conduct RFPs every three years were at risk for fiduciary litigation. The case was eventually settled in 2012 for $9.5 million.

Business owners who sponsor ERISA-governed plans for their employees, such as 401(k) plans, have a fiduciary duty to administer and manage their plans prudently and in the best interest of the plans’ participants and beneficiaries, while ensuring fees are reasonable. By extension, plan sponsors must follow a prudent process to both select and monitor any service providers engaged to support their plans. Therefore, requesting RPFs at regularly scheduled intervals can be part of an effective fiduciary liability reduction strategy and established plan governance program.

An important supplement to the RFP process is annual benchmarking. The two go hand in hand to help protect plan sponsors.  A benchmark report will show how a plan’s fees compare to the average in the marketplace, while the RFP process engages the plan sponsor and provides a means to evaluate the quality of those services.

Conclusion

The DOL assumes plan sponsors solicit RFPs for service providers every three to five years as part of their fiduciary duty to monitor plan service providers. Annual fee benchmark reports supplement the RFPs.  Both are integral parts of a plan sponsor’s fiduciary liability reduction strategy.

[1] Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure

[2] DOL, Meeting Your Fiduciary Responsibilities

 

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