Key Takeaways:
- Forfeiture funds must be used within a defined timeframe to maintain tax-qualified plan status and avoid compliance issues.
- Misuse of forfeitures, especially to reduce employer contributions, can trigger ERISA litigation or regulatory review.
- Regular monitoring, clear documentation, and adherence to plan provisions are essential to mitigate risk.
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For plan sponsors and fiduciaries managing defined contribution plans such as 401(k) and 403(b) arrangements, overseeing forfeiture accounts has become a critical responsibility. While forfeitures are a routine part of plan administration, failure to handle these funds properly can lead to regulatory scrutiny, tax qualification issues, and even litigation under the Employee Retirement Income Security Act (ERISA).
At its core, a forfeiture account consists of unvested employer contributions that revert back to the plan when employees separate before meeting full vesting requirements. These accounts can quietly accumulate over time, and if not used in a timely and compliant manner, they can present significant compliance and operational risks.
Why Oversight Matters
Oversight of forfeiture accounts isn’t merely a best practice; it’s a core fiduciary obligation. ERISA mandates that all plan assets, including forfeiture balances, must be managed solely in the interest of participants and beneficiaries. While many plan sponsors may assume their plan provisions and service providers are handling this correctly, recent developments in litigation and regulatory guidance suggest otherwise.
For example, the IRS has proposed regulations—still pending finalization as of early 2025—that define clear timelines and permissible uses for forfeiture balances. In general, these rules require forfeitures to be used no later than the end of the plan year following the year in which they arise. This creates a relatively short window for action. If forfeitures are allowed to accumulate beyond this period, the plan may be at risk of operational failure and could face consequences that affect its tax-qualified status.
Meanwhile, the Department of Labor (DOL) has taken a growing interest in how forfeitures are used, particularly when they are applied to reduce future employer contributions. Although the DOL has acknowledged this as a permissible use under certain conditions, improper documentation or failure to document alignment with plan provisions may be viewed as a breach of fiduciary responsibility.
Legal Risks and Litigation Trends
In recent years, plan fiduciaries have increasingly found themselves as defendants in lawsuits concerning the handling of forfeiture accounts. More than 70 federal cases have been filed, many of which question whether the use of forfeitures to offset employer contributions constitutes an improper benefit to the employer—something that ERISA strictly prohibits unless it is clearly allowed by the plan and in the best interest of participants.
Even when technically compliant, the appearance of unused or overgrown forfeiture balances can raise fiduciary red flags. In some cases, former employees have alleged that mismanagement of these funds reduced the overall value of the plan, eroding trust and exposing sponsors to reputational risk.
A Proactive Approach to Compliance
Fiduciary responsibility does not end with understanding the rules—it requires active engagement with the plan’s operational practices. This means reviewing the plan document to ensure it includes clear language on how and when forfeitures must be used. It also involves periodic discussions among plan fiduciaries and service providers to confirm that forfeiture balances are being monitored and applied in a timely fashion.
Documentation is essential. Every decision related to forfeiture usage should be backed by meeting minutes or formal records showing that fiduciaries evaluated available options, aligned with plan provisions, and acted prudently. This not only demonstrates compliance but also builds a defensible record should any questions arise.
Annual reviews of forfeiture balances, ideally as part of a broader plan audit or governance process, can help ensure that funds do not remain idle and that usage complies with both IRS guidance and ERISA standards. Where appropriate, plans should take steps to reallocate forfeitures, pay down allowable administrative expenses, or offset contributions in a manner that is transparent and well-documented.
Moving Forward with Confidence
Forfeiture accounts are a normal feature of ERISA-governed retirement plans, but they are also a potential point of vulnerability if not managed with care. As regulatory scrutiny increases and litigation risks persist, plan sponsors have an opportunity to strengthen their fiduciary posture by taking a proactive, documented approach to forfeiture compliance.
Whether through internal assessments or collaboration with plan auditors and legal advisors, staying ahead of these issues supports the long-term integrity of the plan and helps protect the interests of participants. With a well-managed forfeiture strategy in place, sponsors can reduce exposure, improve transparency, and reinforce trust in their retirement benefit programs.
How MGO Can Help
Navigating the complexities of ERISA compliance requires precision, documentation, and a deep understanding of evolving regulatory expectations. MGO’s employee benefit plan team can help plan sponsors and fiduciaries implement practical, compliant strategies for managing forfeiture accounts, so that your funds are used appropriately, within defined timelines, and in alignment with plan provisions. Our team provides tailored guidance on plan document reviews, operational testing, and fiduciary governance to help minimize regulatory and litigation risks. Contact us to learn more.