Use of 401(k) Plan Forfeitures Continues to be Scrutinized in Litigation

In a handful of recent lawsuits, plan sponsors have been questioned about their use of forfeitures assets to reduce employer contributions in 401(k) plans. 

Forfeitures typically occur when an employee leaves a company before fully vesting in the 401(k) plan, thus leaving the employer with excess contributions.  

According to the IRS, which reaffirmed its position in 2023, 401(k) plan forfeitures can be used for any of three permitted purposes: to pay plan expenses, to reduce employer contributions or to make an additional allocation to participants. 

Carol Buckmann, founding partner and ERISA attorney at Cohen & Buckmann P.C., explains that employers cannot take employee turnover into account when determining employer contributions for a 401(k) plan, and the forfeited employer contributions often go into a pooled account in the plan called the “forfeiture account.” 

However, plaintiffs in recent lawsuits have claimed that it is a “prohibited transaction” not to apply the forfeitures for the benefit of participants.  

For example, a participant of the Qualcomm Incorporated Employee Savings and Retirement Plan filed a lawsuit against the company in October 2023, arguing that the company chose to use the forfeited funds in the plan for the company’s own benefit by reducing employer contributions, and thus, violating their fiduciary duties under the Employee Retirement Income Security Act.  

The participant claimed that using the funds in this way “harmed the plan” as well as its participants and beneficiaries, by reducing company contributions that would “otherwise have increased plan assets” and could have been used toward administrative expenses for which participants have to pay. 

Qualcomm in January filed a motion to dismiss the lawsuit, arguing that using forfeitures toward reducing employer contributions is allowed under Treasury Department regulations. However, a federal judge in San Diego denied Qualcomm’s petition to dismiss, stating, “The Supreme Court instructs courts to take a context-sensitive view in ERISA cases and separate meritorious claims from the implausible claims. Taken in context, Plaintiff describes plausible claims for relief.” 

“It’s very interesting because the judge said there isn’t any case law supporting this position that the plaintiffs have taken,” Buckmann says. “But for some reason, he still allowed it to go ahead.” 

Buckmann, who is not involved in the case, also argues that the issue of forfeitures is not a fiduciary decision, as long-standing ERISA policy says that decisions on plan design, how to fund a plan and the level of contributions are “settlor decisions” and not fiduciary in nature. She says applying forfeitures to reduce contributions is “simply an indirect way of setting the level of employer contributions.” 

The Department of Labor has not previously expressed any general concerns about forfeitures, except in a case last year where it successfully sued plan sponsor Sypris Solutions for applying forfeitures to reduce employer contributions in violation of a plan provision that required that the forfeitures first be applied toward plan expenses. According to Buckmann, this lawsuit is not inconsistent with IRS rules because it states under Title 1 of ERISA that fiduciaries must administer plans in accordance with the terms laid out in the plan documents. 

“[Plan sponsors] should make sure that what they’re doing is authorized by the language in the plan,” Buckmann says. 

She says if a plan specifies the order in which forfeitures must be used, it is important that plan sponsors follow such order. Buckmann adds that some benefits lawyers are advising plan sponsors to specify an order in their plan documents so it does not  appear that the sponsor is exercising discretion when determining how the forfeitures will be used, but she says it is too early to conclude if the pending litigation will continue to go on and if they will result in any new case law. 

Similar lawsuits have also been filed against Thermo Fisher Scientific Inc., Intuit Inc. and Clorox Co. 

Buckmann says it is important for plan sponsors to be aware of these cases, as any plan that does not have immediate vesting for participants will ultimately have to deal with forfeitures, and to review their plan language to ensure their use of forfeitures is permitted by the plan documents.