Forfeiting ESOP Participant Non-vested Balances

Posted by Kevin Rusch on Fri, Oct 19, 2012

If a former participant is not 100% vested in their ESOP account balance, they will forfeit their nonvested account balance when they incur a forfeiture event.  The forfeiture event will be determined based on how the ESOP plan document is drafted, most likely using such factors as termination of employment, distribution of vested account balances, and breaks in service.  It is very important to discuss this provision when implementing an ESOP as well as knowing your plan rules to correctly administer the plan.

Forfeiture Timing

Nonvested balances can be forfeited if the participant has incurred 5 consecutive breaks in service, also known as the 5-year break in service rule.  The IRS defines a break in service in IRC §411(a)(6) as a calendar year, plan year, or other 12-consecutive-month period designated by the plan (and not prohibited under regulations prescribed by the Secretary of Labor) during which the participant has not completed more than 500 hours of service.”  

An alternative to using the 5-year break in service rule is forfeiting a non-vested balance upon a cash-out distribution.  This alternative allows a forfeiture to occur prior to the participant incurring 5 consecutive breaks in service.  In order for the cash-out distribution to be a valid forfeiture event, the following requirements must be met, as listed in Treasury Regulations §1.411(a)-7(d)(4):

  • The employee receives a distribution of the present value of his entire nonforfeitable benefit at the time of the distribution

  • If the vested account balance exceeds $5,000, the employee voluntarily elects to receive such distribution

  • The distribution is made due to the termination of the employee's participation in the plan

  • The plan has a repayment provision that restores the forfeiture if the participant returns to employment before incurring 5 consecutive breaks in service and they repay the amount distributed within 5 years of returning to employment

It is very common to see plan documents written to state a forfeiture event will occur the earlier of the 5-year break in service rule or a cash-out distribution.  Be sure to understand the forfeiture timing provisions as written in your plan document to ensure you are following the terms of your ESOP.


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Topics: ESOP Administration

Kevin Rusch
Written by Kevin Rusch

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