Managing Unvested Defined Contribution Plan Funds when Employees LeaveMay 15, 2018
Nonvested contributions from ex-employees may be subject to plan forfeiture. Make sure your plan document addresses the protocol for reporting and using these nonvested amounts.
What happens when employees leave your company with unvested matching contributions or employer contributions building up in their 401(k) accounts?
In essence, the former employee has relinquished his or her claim to those assets. But handling plan forfeitures isn’t necessarily that simple; there can be some variations. So, your plan document must spell out how to address the situation — and those instructions must, of course, be consistent with ERISA requirements. Here’s some guidance.
Detailed records are an essential starting point. When an employee leaves with unvested benefits, your recordkeeper will need to calculate the amount of forfeited funds. That amount identifies how much of the funds are freed up for the company to use for other purposes. But, beware, you might need to return forfeited funds to former employees if they come back to work for you within five years.
Why? In a typical plan, the wording indicates that unvested funds aren’t technically forfeited until after five years. That essentially means those funds are in bookkeeping limbo for five years. Alternatively, your plan document can simply specify that unvested funds are immediately forfeited upon an employee’s departure.
In either case, employees who return within five years may have an opportunity to reclaim those funds. To do so, they must return to your defined contribution plan whatever vested assets they had that were distributed to them upon their departure. Even if employees left before any retirement plan dollars vested and, therefore, didn’t receive a distribution that they’d have to return to the plan, they could still have unvested funds returned to their account if they return within that five-year deadline.
As plan sponsor, what can you do with forfeited funds during the five-year window? You’ve got four options:
- Tap them for future employer contributions.
- Cover plan expenses.
- Allocate them to active participants as an additional contribution.
- Replenish the unvested accounts of employees who return within the five-year window.
Regardless of the option you choose, forfeited funds must be allocated no later than the end of the plan year subsequent to the year in which the employee forfeited his or her funds.
Contact our employee benefit plan specialists for advice on defined contribution plans and more. We can provide additional information on how to handle asset forfeitures in an effective way that complies with the ERISA requirements.