I made a routine check-in call to one of our longtime clients, and offered some updated plan management strategy. “Hey Jeff, I just read about a lawsuit filed against a company that didn’t use their forfeiture account balance in a timely manner. I wanted to make sure you’re on top of that.”
“So help me understand—what exactly is a forfeiture again?” asked Jeff. “Maybe I’m not quite clear on…”
“Sure,” I said. “‘Forfeiture’ is the unvested portion of a participant’s company-funded account—match, or profit sharing. When someone leaves the company and takes a distribution, they get their vested share. The rest gets pulled into the plan’s forfeiture account.”
“And if they don’t take a distribution?”
“Some forfeitures can still happen,” I said. “There’s a rule called the ‘five-year break-in-service.’ After five years of no service, unvested funds can be forfeited—even if they haven’t withdrawn.”
“Okay, so what’s the issue with letting the money sit for a couple years? Can’t we let that build up and apply it to plan expenses whenever it’s convenient? That’s what we’ve always done.”
I smiled. “That used to be the common approach, but not anymore.”
“Why? Did something change?”
“Yes—and it’s not a technical rule change; it’s a legal one,” I explained. “Several companies have been hit with lawsuits for not using their forfeiture balances within 12 months. The argument is that the unvested money should have gone back to plan participants sooner.
“The issue,” I explained, “is one of fiduciary responsibility. If you don’t use those forfeited funds promptly—within the plan year or within 12 months—it will look like you’re hoarding participant money. At least that’s what the lawsuits are claiming. It’s not just bad optics; it’s a real liability. The forfeiture account isn’t a rainy-day fund.”
Jeff paused and took a thoughtful breath. “So what should we be doing instead?”
“There are three main options,” I told him. “Use forfeitures to (1) pay plan expenses, (2) reduce employer contributions—match, safe harbor, or profit sharing—or (3) reallocate them back to participants as additional contributions. But you can’t let those funds sit for years.”
“Okay, I get it. Message received. Will you help us take care of it?”
“Of course. That’s why I called and that’s what we do!”