Plan forfeitures must match plan document.

It’s a routine matter for employees to forfeit retirement plan benefits. Even so, plan sponsors can’t afford to become blasé about it; ERISA demands more than an “easy come, easy go” attitude about the matter.

Forfeiting Benefits

Generally, defined contribution plan participants can forfeit benefits when they leave their companies with unvested dollars still sitting in their accounts (except under circumstances described below). Those forfeited dollars can come from two sources: matching contributions you’ve made to their deferrals, and/ or nonelective contributions you’ve made on their behalf.

The amount of the unvested dollars typically classified as forfeited depends on the vesting schedule you’ve adopted in your plan document, and the timing of an employee’s departure. For example, if you use a three-year cliff vesting schedule, all employer funds set aside for participants who leave before three years are (normally) forfeited, and after three years, participants are 100% vested.

With a graded vesting schedule, if your plan requires the maximum six years of service before full vesting, participants would only be entitled to keep 20% of matching or other employer contributions after two years of service, 40% after three, and so on until reaching 100% after six years of service. (You can opt instead for faster graded vesting schedules if you want to be more generous; ERISA only sets outer limits.) Of course, participants’ own contributions to the plan are immediately vested, as are qualified nonelective contributions and employer safe harbor contributions.

Defining Forfeiture

All of this assumes, however, that your plan document defines forfeiture and what happens to nonvested benefits when an employee leaves. For example, the document may state that, if the participant is 0% vested, he or she forfeits the account immediately on termination of employment. In addition, the document may provide that the unvested portion of a terminated participant’s account will be forfeited in the year of termination or after a five-year break in service. Forfeitures are generally held in a “forfeiture account” to be used when the plan document specifies. Generally, plan sponsors use forfeitures to pay plan expenses, reduce employer contributions and/ or use in addition to any employer contributions being made.

Why might you hold forfeitures for a period of five years? Under ERISA, a former plan participant who returns to the company and rejoins the plan within five years has another crack at claiming those unvested assets. If the company had used these funds prior to the participant’s return, it will need to make contributions to the plan to restore the account.

In either case, however, ERISA sets a high bar for returning employees to regain title to those assets. Specifically, if the former employee had received a distribution of any vested funds when leaving the company, that employee would have to return all of those dollars to the plan before having the opportunity to get those unvested dollars back. And if the returning employee cleared that first hurdle, the unvested funds to be restored would still be unvested.

Be Consistent

Plan recordkeepers must keep scrupulous records of every penny in your plan and which of the many buckets they belong in. Review how your recordkeeper is tracking forfeitures. Finally, be sure that the way you’re handling forfeitures is consistent with the fine print in your plan document that prescribes these procedures.

Plan Forfeitures Must Match Plan Document.

However you define forfeiture, you have to do something with the unvested dollars left in the plan when a participant leaves the company. So, what are your options? Let’s summarize:

• You can redeploy those dollars toward your commitments to matching or nonelective contributions to plan participants. Or if you’re feeling generous, allocate them to participant accounts. To do so, however, you’ll need to have language in your plan document that describes how those funds would be allocated among participants and eligibility requirements. Also, these allocations would count toward the participant’s limit on total annual additions, so you might not be able to allocate all forfeitures that way.
   
• You can also use forfeited dollars to pay reasonable plan expenses. Finally, you can use them to restore previously forfeited amounts to participant accounts. That is, if a former employee returns within the five-year window and returns previously distributed funds, as required, the dollars forfeited by other employees get recycled into the nonvested accounts of those returning employees.

Chances are, you won’t need to exercise this last option because it’s not a common occurrence for former participants to return within five years and restore distributions they took when they left. Still, it’s a good tactic to be aware of should the need arise.

Whichever path you choose, you have a deadline to get it done: the end of the plan year following the plan year in which the forfeiture occurred.

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Sometimes overseeing a retirement plan might feel like navigating a minefield. With proper precautions, however, you can get through safely. Case in point: Making sure your plan is operating consistently with its plan documents.

Erisa Requirements

Although running your plan consistently with plan documents might sound like a straightforward proposition, this isn’t always the case. As a reminder, ERISA requires plan fiduciaries to discharge their duties solely in the interest of participants and their beneficiaries “in accordance with the documents and instruments governing the plan.”

An employer defending itself in a recent class action suit primarily involving alleged violations of the Fair Labor Standards Act was blindsided by an accusation that it had also violated ERISA. How? Because the disputed wages were “eligible compensation” under the employer’s retirement plan, as described in its plan document, ERISA applied as well.

Applicable Documents

ERISA’s mandate requires employers to know the directives of their plan documents and run the plan accordingly. To do so, you must first confirm that your plan documents are ERISA-compliant.

Underlying those two imperatives is the assumption that you know which documents are the governing “plan documents.” There’s no doubt that the core document explaining how the plan operates comes under this heading, but you may have other written pronouncements tucked away that could be deemed plan documents in litigation.

For example, investment policy statements, as well as plan loan and qualified domestic relations order procedures, might also be plan documents if audited or subjected to legal scrutiny. Even an unsigned plan amendment might. While of course you wouldn’t knowingly write a document that violates ERISA, inconsistencies could easily arise if you don’t subject it to the same level of review as a core plan document. Ask your attorney to look at all such items and help you decide which ones are plan documents.

Also, don’t draft documents, such as investment policy statements, because you think you should, but then not actually follow them. What would be worse: having a document, such as an investment policy statement, and not following it or not having one at all? It’ll be a case-bycase determination.

And here’s another sobering reminder: The IRS Employee Plans Compliance Resolution System won’t necessarily get you off the hook with respect to plan document violations involving a fiduciary breach that causes financial harm to the plan. That’s because such matters generally fall under the purview of the Department of Labor, not the IRS.

An Ounce of Prevention

As you review your various policy statements, consider explicitly and legally identifying which ones are plan documents and which aren’t. Doing so will not only ensure that everything’s ERISA-compatible, but also prevent you from inadvertently making promises that you can’t keep.

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Service organization control (SOC) reports come in several varieties. They generally pertain to service organizations, like retirement plan recordkeepers or third party administrators (TPAs). The American Institute of Certified Public Accountants (AICPA) determines the scope of each SOC report.

Types of SOCs

The AICPA has three categories of SOC reports on the services provided by a service organization:

SOC 1: ICFR: Report on Controls at a Service Organization Relevant to User Entities’ Internal Control over Financial Reporting. If your retirement plan is being audited, the auditor might look for your service providers’ SOC 1 reports to assess his or her comfort level with those service providers’ financial statements. There are two subcategories of SOC 1 reports that have different emphases.

SOC 2: Trust Services Criteria: Report on Controls at a Service Organization Relevant to Security, Availability, Processing Integrity, Confidentiality or Privacy. This report, if it paints a good picture, should give you comfort that, among other things, your plan participants’ identities won’t be stolen by a hacker. As with SOC 1, there are two SOC 2 subcategories.

SOC 3: Trust Services Criteria for General Use Report. These are described as “general use reports” that don’t go into the same level of depth as SOC 2 reports.

Reason for SOCs

Service organizations generally can provide these reports more efficiently and cost effectively than qualified plans and have made these services the focus of their business model. They generally pay to have their control systems reviewed by CPAs, who can in turn create the appropriate SOC report from the assembled information. These reports “are designed to help service organizations that provide services to other entities build trust and confidence in the service performed and controls related to the services,” according to the AICPA. The success or failure of the SOCs can impact an organization’s reputation, financial statements and stability.

As part of your due diligence procedure, when vetting prospective service providers for your retirement plan, review their SOC reports. If that step was overlooked in past years, request and review the SOC reports they can provide. In addition, haveyour CPA also read  them to make sure you didn’t overlook any red flags.

If the reports raise any issues, document your concerns and monitor the providers’ progress toward addressing them. And if that doesn’t happen, it’s probably time to start a fresh vendor search.

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