On the Hot Seat: 401(k) Plan Forfeitures

401(k) plan forfeitures have been a hot topic lately given the increase in ERISA class action lawsuits challenging their use. So, what are forfeitures? Forfeitures are employer contributions that participants forfeit when they leave employment before the contributions vest (if they are subject to a vesting schedule). Typically, the forfeitures stay in the plan and are later used to pay plan expenses, to reduce employer contributions, and/or are allocated to eligible plan participants. However, they must be used by no later than twelve months following the end of the plan year in which they arose. The plan document may state specifically how the forfeitures are to be used, or it may give discretion to the plan administrator to choose.

Forfeitures Under Review

Although the use of forfeitures to reduce employer contributions has been a common practice allowed under regulatory guidance, plaintiffs are alleging that utilizing them for this purpose violates several provisions of ERISA. They argue that plan administrators, as fiduciaries to the plan, are violating their duty of loyalty and prudence by using the forfeitures in a way that indirectly benefits themselves; that is, by choosing to use the forfeitures to reduce employer contributions, the plan administrators are prioritizing the employer’s financial interests over the best interests of the plan and its participants. Plaintiffs also assert that this practice: (1) violates ERISA’s anti-inurement provision because using forfeitures to offset future employer contributions causes plan assets to “inure” to the benefit of the employer, not participants; and (2) constitutes an ERISA-prohibited transaction because it amounts to self-dealing by reducing the amount of contributions an employer has to make to the plan.

The U.S. Department of the Treasury has addressed how ERISA-covered defined benefit pension plans may handle forfeitures: they must be used as soon as possible to reduce the employer’s contributions under the plan. In 2023, the Treasury Department reaffirmed its position and proposed another Regulation regarding defined contribution plan forfeitures, including 401(k) plans forfeitures, which would permit the forfeited employer contributions to be used for three purposes “as specified in the plan: (1) to pay plan administrative expenses, (2) to reduce employer contributions under the plan, or (3) to increase benefits in other participants’ accounts in accordance with plan terms.” If adopted, the 2023 regulation would allow the customary practice of using forfeitures to offset future employer contributions to continue. ERISA remains silent regarding the permitted use of forfeitures, and the DOL has never stated that the use of forfeitures to offset future employer contributions violates ERISA.

A Risk Mitigation Approach

To date, there have been more than thirty forfeiture lawsuits filed against companies of all sizes. Some plaintiffs have had success, but there have generally been inconsistencies by the courts, and none of the cases have been decided by an appeals court. Given the uncertain legal landscape, now is a good time for plan sponsors to be proactive and implement risk mitigation strategies. At a minimum, they should evaluate their plan’s forfeiture terms and ensure that the use of plan forfeitures is consistent with the plan provisions. They may also consider:

• Removing any discretionary language from the plan document regarding the use of forfeitures, or
• Amending the plan to specify that forfeitures must first be used to reduce employer contributions and then to pay administrative expenses.

Plan sponsors should also ensure transparency in their communications with participants on the use of forfeitures. This includes clearly communicating the forfeiture process and how forfeitures are to be used through the plan document, summary plan description, and other plan communications. Finally, plan sponsors should conduct regular audits to ensure that the forfeitures are being used in accordance with the plan document and applicable law.

Please contact us if you have questions about the information outlined above; our seasoned and experienced employee benefit plan professionals are here to help. You can also learn more on our Employee Benefit Plan services page.

About the Author

Related Services