Source: https://www.irs.gov/retirement-plans/improper-forfeiture-by-defined-benefit-plans
Timestamp: 2019-04-24 18:06:05+00:00

Document:
Most defined benefit (DB) plans cannot forfeit a participant’s benefit after 5 consecutive 1-year breaks-in-service. However, some DB plans include language providing for a forfeiture of a participant’s non-vested accrued benefit either when a participant terminates employment or after the participant incurs 5 consecutive 1-year breaks-in-service. If the plan language forfeits the non-vested benefit upon termination, the plan document must also provide that the plan will restore the forfeited amount if a forfeited participant returns to service prior to incurring 5 consecutive 1-year breaks-in-service. This Issue Snapshot only addresses the involuntary cash-out rules in relationship to improper forfeitures of a participant’s vested accrued benefit by defined benefit plans. This Issue Snapshot does not address the provisions of DOL Reg.§ 2530.204-1(b).
IRC § 411(a)(6)(C) allows defined contribution (DC) plans and fully insured defined benefit plans to forfeit the nonvested portion of the accrued benefit after 5 consecutive 1-year breaks-in-service.
IRC § 411(a)(6)(D)(i), also called the “rule of parity”, provides that in the case of a nonvested participant, years of service (YOS) with the employer before any period of consecutive 1-year breaks-in-service shall not be required to be taken into account if the number of consecutive 1-year breaks-in-service exceeds the greater of (a) 5, or (b) the aggregate number of YOS before such period.
411(a)(6)(C) provides that the YOS that were earned after the break-in-service (post-break service) do not have to be used to increase the vested percentage associated with the accruals earned prior to the breaks-in-service (pre-break accrued benefit).
IRC § 411(a)(6)(D) provides that if a participant is not vested in any of his accrued benefit then the YOS prior to the breaks-in-service (pre-break service) do not have to be used to determine the vesting percentage of the participant in the employer-derived accrued benefit.
In other words, for IRC § 411(a)(6)(C),because a nonvested or partially vested participant who has a 5 consecutive 1-year breaks-in-service cannot increase his or her vested percentage in the pre-break-accrued benefit, the plan can forfeit the non-vested accrued benefit that accrued prior to the 5 consecutive 1-year breaks-in-service. However, IRC § 411(a)(6)(C) only applies to DC or fully insured DB plans. All other DB plans may not forfeit a partially vested participant’s non-vested portion of his or her accrued benefit that accrued prior to 5 consecutive 1-year breaks-in-service.
Under IRC § 411(a)(6)(D),for a non-vested participant, a plan is allowed to disregard any YOS earned prior to a period of 1-year breaks-in-service where the number of 1-year breaks-in-service is the greater of (a) 5, or (b) the aggregate number of YOS before such period of 1-year breaks in service when determining the total years of vesting service required to be taken into account in determining the vesting percentage after the participant returns to service. IRC § 411(a)(6)(D) does not apply to partially vested participants.
IRC § 411(a)(7)(B)(i) allows plan documents (including DB documents) to provide for immediate involuntary distributions upon termination of employment of a participant’s entire nonforfeitable benefit if the amount is not in excess of the IRC § 411(a)(11)(A) dollar limit and also immediately forfeit the non-vested portion of the accrued benefit. In order to contain this provision, the plan document must state that it is going to make involuntary distributions upon a participant’s termination from employment and also must state that the forfeited portion will be reinstated if the participant timely repays the distribution upon returning to employment. In other words, a plan document that includes a “cash out” provision must also contain repayment or “buy back” language.
Plan A, a non-insured DB plan, provides in the plan document, for forfeiture of a participant’s non-vested accrued benefit upon the participant’s termination of employment. The plan document also provides that if such a participant returns to employment prior to incurring 5 consecutive breaks-in-service, the plan will restore the participant’s non-vested accrued benefit that was forfeited upon the participant’s termination of employment. The plan document contains a 5 year cliff vesting schedule. The plan language includes the “Rule of Parity.” The plan does not include language allowing for a forfeiture upon a cash-out or “deemed” cash-out distribution(1).
Taylor starts working for company A and started earning vesting and benefit accrual YOS. Taylor completed 4 YOS for vesting and accrual purposes. The present value of Taylor’s accrued benefit under the DB plan was $1000 after these 4 years.
Taylor terminated employment and incurs 4 consecutive 1-year breaks-in-service. Based on the plan terms, Plan A forfeits Taylor’s total accrued benefit of $1,000, as he was zero percent vested.
Taylor returns to service and earns a year of service, prior to incurring 5 consecutive 1-year breaks-in-service. Based on the plan terms, the plan reinstates the $1,000 accrued benefit that was forfeited upon Taylor’s termination of employment.
Solution: The fact that the plan reinstated the $1,000 forfeited accrued benefit upon Taylor’s return to employment does not negate the fact that the plan improperly forfeited Taylor’s accrued benefit.
As Taylor returned and earned a year of service prior to incurring 5 consecutive 1-year breaks-in-service, and he was a participant in a non-insured DB plan, the plan may not use the provisions of IRC §§ 411(a)(6)(C) or (D) to forfeit Taylor’s accrued benefit.
As there was no provision for a cash out, or a “deemed” cash out distribution, the plan may not use the provisions of IRC § 411(a)(7)(B)(i) to forfeit Taylor's non-vested accrued benefit.
Some taxpayers argue that since the plan provides for restoration of Taylor’s accrued benefit, there is no improper forfeiture.
However, IRC § 411(d)(3) requires that all affected participants be fully vested upon a full or partial termination of the plan. If Plan A were to experience such a termination prior to Taylor returning to employment, IRC § 411(d)(3) requires Taylor to be fully vested in his accrued benefit of $1,000 because he is an affected participant. Based on the plan’s terms, Taylor’s accrued benefit was improperly forfeited when he left employment.
Plan B, a non-insured DB plan, provides in the plan document, that the plan will forfeit a participant’s non-vested accrued benefit upon the participant’s termination of employment. If the participant returns to employment prior to incurring 5 consecutive breaks-in-service, the plan will restore the participant’s non-vested accrued benefit that was forfeited upon the participant’s termination of employment. The plan uses a 7 year graded vesting schedule. The plan language includes the “Rule of Parity.” The plan does not include language allowing for a forfeiture upon a cash out, or a “deemed” cash out distribution.
Taylor started working for company B and started earning vesting and benefit accrual YOS. Taylor completed 4 YOS for vesting and accrual purposes. The present value of Taylor’s accrued benefit under the DB plan was $1000 after these 4 years.
Taylor leaves company B after earning 4 years of vesting service. Based on the plan’s vesting schedule, he is 40% vested in his accrued benefit as of the date he terminates employment.
Based on the plan’s terms, the plan forfeits $600 of Taylor’s accrued benefit, which represents Taylor’s non-vested accrued benefit.
Taylor returns to service, after incurring 5 consecutive 1-year breaks-in-service. Based on the plan’s terms, the plan does not restore Taylor’s non-vested accrued benefit as he returned to service after incurring 5 consecutive 1-year breaks-in-service.
Solution: Plan B has improperly forfeited $600 of Taylor’s accrued benefit. As this is a non-insured DB plan, it may not forfeit Taylor’s non vested accrued benefit under IRC §411(a)(6)(C), as that section of the Code only applies to a DC plan or a fully insured DB plan.
Plan B may not use the “rule of parity” provisions of IRC § 411(a)(6)(D) to disregard Taylor’s YOS earned prior to the 5 consecutive 1-year breaks- in- service as the “Rule of Parity” only applies to a non-vested participant.
As there was no provision for a cash out distribution, the plan may not use the provisions of IRC § 411(a)(7)(B)(i) to forfeit Taylor's non-vested accrued benefit.
As in example 1, if Plan B were to experience a partial or full termination prior to Taylor returning to employment, the plan would be required to fully vest Taylor in his accrued benefit of $1000 as he would be an affected participant under IRC §411(d)(3).
If the plan is a non-insured defined benefit plan, Determination Specialists and Examiners should insure that the plan document does not allow for an improper forfeiture by allowing the plan to forfeit a participant’s non-vested accrued benefit if the participant incurs 5 consecutive 1-year breaks-in-service. Absent cash out language, or “deemed” cash out language, a noninsured defined benefit plan cannot forfeit a participant’s accrued benefit. If the plan is attempting to use the “Rule of Parity” to disregard years of service earned prior to a break in service, Determination Specialists and Examiners should insure that the provisions of IRC §411(a)(6)(D) only apply to a non-vested participant.
If a defined benefit plan terminated or experienced a partial termination, all of the “affected” employees must be 100% vested in their accrued benefits. Any participant/former participant that did not receive a distribution of his or her entire accrued benefit should be reviewed carefully to insure that there are no improper forfeitures.
(1) A plan is allowed to provide that if the present value of an employee's vested accrued benefit is zero, the employee shall be deemed to have received a distribution of such vested accrued benefit, provided that the plan also includes the appropriate repayment language in the plan.

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