FLASH IN THE PLAN: EN GARDE!! THE CHALLENGE WITH FORFEITURES

By: Alison J. Cohen, Esq.

You may have been reading in the news about the recent uptick in ERISA class action lawsuits relating to the use of forfeitures. This issue will be relevant to your plan if you have employer contributions and apply a vesting schedule to those funds.

What is a Forfeiture?

An Employer may design its retirement plan so that contributions it makes for its participants are subject to a vesting schedule. The vesting schedule means that the participant earns the right to those contributions over a period of employment, based on that schedule. For example, a plan may apply a five-year vesting schedule, where a participant earns 20% of their benefit for each year of service (i.e., becomes 20% vested after one year, 40% vested after two, etc.) The longest permissible vesting schedule is six years. A “year of service” is usually a plan year in which the participant is paid for 1000 or more hours of service. If the participant stops working for the company prior to earning 100% vesting on the schedule, then the unvested portion is called a “forfeiture.” The forfeiture is removed from the participant’s account and placed into a forfeiture account. The forfeiture account acts like a suspense account for these funds until they are later used within the plan for certain purposes, based on the terms of the plan document.

How May Forfeitures be Used by the Plan?

There are three ways that forfeitures may be used within the plan:

1. to pay administrative fees;
2. to reduce employer contributions; and/or
3. the forfeiture may be allocated to eligible participant accounts to increase their benefits.

The plan document may state a specific use for the forfeitures from this list, or it may grant complete discretion to the Plan Administrator to select how (among the three options) the forfeitures will be used.

Forfeitures must be used by no later than 12 months following the end of the plan year in which they arose. For example, suppose you have forfeitures that arose in 2024 when a participant terminated employment and took their vested interest. That forfeiture must be used not later than the end of 2025. If the plan provides that forfeitures are used to pay plan expenses, the plan can use them to pay for the annual Form 5500 preparation or for the 2024 Form 5500 audit, even if those invoices are paid in the summer of 2025.

Why Are Employers Getting Sued?

There are a few variations of the lawsuits that have been filed, but participant-plaintiffs are essentially arguing 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. In particular, when the plan permits the Plan Administrator to choose whether to use forfeitures to pay for plan expenses (which would otherwise be paid by participant accounts) or reduce employer contributions, the employer that uses forfeitures to reduce its contribution is prioritizing the employer’s financial interests over the best interests of the plan and its participants.

Although the Internal Revenue Service has long approved the language permitting discretionary forfeiture use, and the language mentioned above is consistent with the historically permissible options outlined in the Internal Revenue Code, these new claims by the participant-plaintiffs have had some success in the courts. However, courts in different areas of the country are ruling differently, and none of the cases has yet been decided by an appeals court.

To avoid being a possible target for these often frivolous lawsuits, many employers are amending their plans or adopting a written administrative policy that clearly states how forfeitures will be used. The idea: remove the discretion and you remove the potential for the claim of fiduciary breach for making the “wrong” choice.

 What Should a Plan Sponsor Do Now?

Plan Sponsors should talk to their third-party administrators (“TPA”) or service providers to determine what the language of their plan document currently says. In some plan documents, the language permits the Plan Administrator to “elect to use any portion of the Forfeiture Account to pay administrative expenses incurred by the Plan.” It may go on to say that forfeitures may also be applied at the direction of the Plan Administrator in any of three different options. This type of language is fully discretionary and open-ended, which is precisely what the lawsuits are trying to prevent.

Plan Sponsors may request that their TPA or document service provider prepare an amendment to the Plan to formalize a mandatory use for forfeitures in the future, removing the discretionary language. This has the best chance of avoiding a claim that the sponsor has improperly used the forfeitures. Even if this language dictates that forfeitures are used first to reduce employer contributions and only used to pay expenses thereafter, the lack of discretion eliminates the potential for courts to find that there was a choice made that constitutes a fiduciary breach.

If you have any questions about the use of forfeitures or about how you can alter your plan document to clearly state the intended use, let us know. Remember: we are your ERISA Solution!

Talk to Your TPA:

If your plan has more than 100 participant account balances as of the first day of the plan year, you are required to complete and attach an independent qualified auditor’s report to the Form 5500.  This audit process takes a considerable amount of time and should be started as soon as possible to allow at least 3 months to complete.  You can find qualified CPA firms on the AICPA website.

Key Dates:

7/31/25: Form 5558 filing deadline to extend Forms 5500 and 8955-SSA due date for calendar year plans (7 months after plan year end)

9/15/25: Extended employer contribution deposit deadline for partnerships and S-corp entities (6 months after unextended due date)

9/15/25: Deadline to fund pension contributions (8.5 months after plan year end)

10/01/25: Deadline to implement deferrals for new 401(k) safe harbor plans for a 2025 short plan year (10/1-12/31)