As retirement plan litigation continues to evolve, plan sponsors face increasing scrutiny over their fiduciary processes and plan administration practices. One area that has recently come under the microscope is the use and handling of forfeitures—plan assets that revert to the plan when a participant terminates employment before becoming fully vested. Historically seen as a routine administrative matter, forfeitures are now being examined in lawsuits as potential breaches of fiduciary duty. This new attention demands that plan sponsors reevaluate their forfeiture practices through a risk management lens.
In qualified retirement plans, such as 401(k)s, employer contributions—particularly matching and profit-sharing contributions—are often subject to vesting schedules. If an employee terminates employment before fully vesting in these contributions, the unvested portion is “forfeited.” These forfeitures are not simply discarded; they remain plan assets and must be used in accordance with IRS and ERISA rules.
The IRS permits forfeitures to be used for specific purposes:
Importantly, forfeitures cannot be reallocated directly to other participants' accounts except under specific plan provisions. And they must generally be used within a reasonable timeframe.
Since fall 2023, more than 30 class action lawsuits have been filed claiming that using 401(k) forfeitures to reduce future employer contributions breaks ERISA rules, including fiduciary duties and rules against benefiting the employer. Even though the U.S. Department of the Treasury has clearly said this practice is allowed (and it’s been done for decades), plaintiffs have gained traction with some courts on this new legal theory.
One emerging legal argument is that plan sponsors are “hoarding” forfeitures—allowing them to accumulate over multiple years without a clear plan for usage. Plaintiffs argue that this inaction results in unnecessary plan expenses, which could have been offset by timely use of forfeitures. In effect, participants argue that mismanagement of forfeitures leads to avoidable costs, and therefore, fiduciary breach.
Some plans have also been criticized for a lack of documentation regarding how and when forfeitures are applied. Regulators and courts alike may view poor recordkeeping as a red flag—suggesting a lack of oversight and procedural prudence.
Another area of focus is alignment between plan documents and actual practice. If the plan document specifies how forfeitures are to be handled (e.g., applied annually to offset employer contributions), any deviation from that process—even if unintentional—could expose sponsors to legal risk.
There are several operational challenges that commonly trip up plan sponsors:
Given the heightened attention, plan sponsors should revisit their forfeiture policies and procedures with both compliance and litigation risk in mind. Here are several best practices to consider:
Review the Plan Document. Confirm how forfeitures are to be used and the timeframe for their application. If the language is vague or out of date, consult with ERISA counsel and consider amending the document for clarity.
Establish a Formal Policy. Develop and document a clear internal policy for handling forfeitures. Define when forfeitures are reviewed, how decisions are made about their use, and who is responsible for those decisions.
Apply Forfeitures Timely. The IRS expects forfeitures to be used “as soon as reasonably possible.” Ideally, this means using them within the same plan year they arise. Develop a cadence—quarterly or annually—for reviewing and applying forfeitures.
Coordinate with Service Providers. Ensure that your recordkeeper, third-party administrator (if applicable), and plan counsel are aligned on how forfeitures are tracked and used. Miscommunication or role confusion can lead to errors or inaction.
Maintain Documentation. Keep detailed records of how and when forfeitures are applied, including committee meeting minutes, emails, and administrative reports. This documentation can be critical if your fiduciary decisions are ever challenged.
Consider Plan Amendments if Needed. If the current plan design does not offer flexibility or clarity around forfeiture usage, amending the plan may be appropriate. For example, some plans may benefit from explicitly allowing forfeitures to be applied quarterly rather than annually.
While forfeitures might at first seem like a minor issue compared to fund lineups or cybersecurity, their growing role in ERISA litigation makes them a serious risk area. Plaintiffs’ attorneys are now looking at the totality of fiduciary oversight, and any operational lapse—however small—can be framed as part of a broader pattern of neglect.
The key defense in any fiduciary lawsuit is having a sound process. Courts typically won’t second-guess a decision made through a prudent and consistent process—even if the outcome wasn’t perfect. But if there’s no documentation, no process, and no adherence to plan terms, fiduciaries are exposed.
Informational Resources: Holland & Knight: “An Emerging Trend in ERISA Class Action Litigation: 401(k) Forfeiture Suits” (January 22, 2025); PlanSponsor: “Use of 401(k) Plan Forfeitures Continues to be Scrutinized in Litigation” (June 5, 2024); Carlton Fields: “Practical Thoughts for Sponsors About Current ERISA Forfeiture Litigation” (September 30, 2024); Vanguard Institutional: “Avoiding Pitfalls in Retirement Plan Forfeitures” (November 2024).