Navigating Forfeitures in Retirement Plans
Published on by Joe Conover, Jessica Doremus, in Benefit Plan Audits, Tax Services
The utilization of forfeitures in retirement plans has become a focal point in the ERISA litigation landscape. Forfeitures typically occur when an employee terminates their employment before their employer contribution becomes fully vested, resulting in the unvested portion reverting to the plan’s forfeiture account.
Recently, lawsuits alleged that employers are failing their fiduciary duty by using forfeited funds to offset future employer contributions instead of reducing administrative expenses, often borne by participants. This trend in litigation could potentially disrupt conventional practices in managing defined contribution plans.
Understanding forfeitures
Forfeitures are generated in defined contribution plans with a vesting schedule for employer contributions. When an employee terminates and takes a distribution before being fully vested, the unvested portion remains in the plan as a forfeited account balance. The plan’s document outlines the exact criteria for when a forfeiture occurs, and it is crucial for plan administrators to operate within these terms to maintain the plan’s tax-qualified status.
Forfeiture use and litigation risks
Recent lawsuits, such as the one filed by Schlichter Bogard in the Eastern District of Missouri in February 2025, argue that forfeitures are plan assets and should exclusively benefit the participants, rather than reducing a plan sponsor’s match contribution. This perspective aligns with the fiduciary duty of loyalty and prudence under ERISA. However, the Internal Revenue Service (IRS) allows for the practice of offsetting matches, setting the stage for a potential legal showdown that may reach the U.S. Supreme Court.
Mitigating risks
To mitigate potential legal exposure, plan sponsors should consider the following strategies:
- Review and Revise Plan Documents: The plan document should clearly specify how forfeitures are to be used. To enhance the plan’s forfeiture provision, consider specifying an order of priority for the use of forfeiture dollars. Removing fiduciary discretion in the use of forfeitures can also help to reduce risk.
- Establish a Monitoring System: Regularly review the plan’s usage of forfeitures, ensure that funds are allocated correctly, and verify compliance with plan document terms.
Have a plan in place
The current legal landscape necessitates a proactive approach from plan sponsors in reviewing their plan documents and ensuring precise language to mitigate potential risks. As the forfeiture issue continues to evolve, maintaining open communication with participants, regularly monitoring forfeiture usage, and seeking professional assistance can help navigate these complex challenges effectively.
Want to discuss forfeiture use and how your business can mitigate the risk of litigation? Contact us today for a free consultation with one of our employee benefit plan experts. As always, we’re here to help.
