Is Your Retirement Plan Properly Handling Forfeited Account Balances?

Forfeitures from a defined contribution retirement plan are often a component that receive limited attention unless issues arise. As we move into 2026, forfeiture handling should no longer be treated as an operational afterthought. Plan sponsors should instead take a proactive approach to managing and utilizing forfeitures to help mitigate compliance risks and potential exposure to class action litigation.

What Are Forfeitures?

Forfeitures arise when a participant leaves employment before becoming fully vested in their employer contributions. The non‑vested portion of those contributions is forfeited by the participant and is removed from the participant’s account and deposited into an unallocated holding account. 

Permitted Uses of Forfeited Amounts

These unallocated forfeited amounts may only be used in ways specifically authorized by the plan document.  The provisions selected when drafting the plan document will vary between different retirement plans.  The most common permissible uses include the following:

• Pay administrative expenses of the Plan
• Reduce future employer contributions
• Reallocated as additional employer contributions to existing participants

Where Plan Sponsors Commonly Get It Wrong

Forfeitures Accumulating Without Action

Plan sponsors allow the forfeiture balances to accumulate for long periods of time without using them.  The Internal Revenue Service regulations require forfeitures to be used by the Plan no later than the end of the Plan year following the year in which they occurred. Not using them in accordance with these regulations may create a compliance issue that could need corrected under the IRS’s Employee Plans Compliance Resolution System..

Using Forfeitures Inconsistently with the Plan Document

Forfeitures are Plan assets and must be used strictly in accordance with the permitted uses spelled out in the provisions of the Plan. Using them inconsistently with those provisions results in a compliance error that will likely need corrected to maintain the qualification of the Plan.

How to Minimize Litigation Risk

Forfeitures have recently come under increased scrutiny in recent years under class-action litigation brought against Plan fiduciaries. While many of these cases have not been successful, defending this litigation can result in administrative burden as well as significant legal costs.  Any ambiguity or inconsistent use of forfeitures can create legal exposure for the Plan Sponsor.  To minimize risk, Plan Sponsors should ensure forfeitures are being used in a timely fashion and that they are being used in accordance with the provisions of the Plan.  Additionally, some ERISA attorneys recommend that Plan sponsors clearly specify one primary use for forfeitures within the Plan document, such as either paying administrative expenses or reducing future employer contributions.  Multiple permitted uses without clear prioritization may expose the plan to litigation if participants can argue that forfeitures were applied in a manner that favored the employer over their interests.

Best Practices Recommended for Plan Sponsors

• Review the forfeiture provisions included within the Plan document
• Establish a formal process to properly administer the unallocated forfeiture balances
• Coordinate regularly with your third-party administrator to ensure forfeitures are used in a timely fashion and appropriately

Additional Questions?

I hope you find this summary helpful in reducing the compliance risk for administering your accumulated forfeiture balances.  If you have any questions or would like to discuss further, feel free to reach out to me or any member of the MPB employee benefit plan team.