Recent lawsuits spark renewed attention on how retirement plan funds are used

A little-known feature of many 401(k) plans is now drawing national attention, as regulators and courts weigh in on how employers use so-called “forfeitures,” which are funds left behind when employees leave before fully vesting in company contributions.

While the concept has existed for decades, a wave of class action lawsuits filed beginning in late 2023 has challenged how these funds are applied. This has prompted new guidance from the U.S. Department of Labor (DOL) and the Internal Revenue Service (IRS).

What Are Forfeitures?

In many employer-sponsored retirement plans, company contributions are subject to vesting schedules. If an employee leaves before earning full ownership of those contributions, the unvested portion is returned to the plan. These amounts are known as forfeitures.

Importantly, forfeited funds do not revert to the employer. Instead, they must remain within the plan and be used in ways that benefit the plan and its participants.

Why the Sudden Attention?

Historically, employers have used forfeitures in several accepted ways. These include reducing future employer contributions, covering administrative costs, or reallocating funds to other participants.

However, recent lawsuits have argued that using forfeitures to offset employer contributions may unfairly benefit employers instead of participants. Plaintiffs claim this practice violates fiduciary duties under the Employee Retirement Income Security Act (ERISA), even when plan documents permit such use.

Regulators Weigh In

Federal regulators have largely reinforced long-standing practices.

In a notable development, the DOL filed a brief in a high-profile case stating that using forfeitures to reduce employer contributions does not, by itself, violate ERISA. The agency emphasized that this approach has long been accepted and aligns with existing tax rules.

Separately, the IRS issued proposed regulations in 2023 confirming that forfeitures may be used to:

• Pay plan administrative expenses
• Reduce employer contributions
• Increase participant benefits

The IRS also introduced clearer timing requirements. In most cases, forfeitures must be used within 12 months after the end of the plan year in which they arise.

Court Decisions Trending Toward Employers

So far, most courts reviewing these claims have dismissed them at early stages. This is especially true when plan documents clearly outline permissible uses and employers follow those terms.

Legal observers note that while some cases remain ongoing, the broader trend suggests that well-documented and properly administered plans are likely to withstand legal challenges.

What Employers Should Do Now

Despite favorable regulatory signals, experts recommend that plan sponsors take proactive steps to reduce risk, including:

• Reviewing plan documents for clarity and alignment with current practices
• Ensuring forfeiture usage matches plan terms
• Monitoring timing to comply with IRS guidance
• Documenting decision-making processes
• Updating participant communications for transparency

Looking Ahead

The recent wave of litigation has brought new visibility to a long-standing retirement plan feature. While regulators have reaffirmed the legality of common forfeiture practices, ongoing court decisions may continue to shape how these rules are applied.

For employers, the takeaway is simple. Consistency, documentation, and transparency matter more than ever.

About SingerLewak and How We Can Help

SingerLewak’s Employee Benefit Plan and Tax Advisory teams work closely with plan sponsors to navigate evolving regulatory guidance, assess plan design, and align operational practices with current legal standards. As scrutiny around forfeiture usage continues to grow, proactive review and documentation are key to reducing risk.

To learn more about how your organization can evaluate and strengthen its retirement plan practices, contact SingerLewak or visit www.singerlewak.com to connect with our team.