Retirement Plan Forfeitures: A Primer

Retirement plan forfeiture litigation has exploded in recent years, with over 40 class action lawsuits filed in just the past two years. While many of these cases get dismissed, some are surviving dismissal and even leading to healthy settlements. Just look at Rodriguez v. Intuit, Inc., which recently settled for $1,995,000. With all this activity, there’s no better time to refresh your knowledge of plan forfeiture rules and best practices.  

Plan Forfeitures, Generally

A forfeiture occurs when the non-vested portion of an employee’s defined contribution plan account balance is returned to the plan, typically after the employee terminates employment or has a significant break in service. Forfeitures are not a free-for-all; they’re governed by the Internal Revenue Code of 1986 (the “Code”) and the Employee Retirement Income Security Act of 1974 (“ERISA”), which set clear limits on how and when employers can use and allocate forfeited benefits.

The IRS recently issued proposed regulations clarifying that plans must use forfeitures no later than “12 months after the close of the plan year in which the forfeitures were incurred.”  Generally, ERISA and the IRS allow plans to use forfeitures for the following uses:

• Pay permissible, reasonable plan expenses;
• Reduce future employer contributions;
• Reallocate the forfeitures among the accounts of active plan participants; or
• Restore previously forfeited participant accounts.

Most plan documents are flexible and allow for several of these options, giving administrators the freedom and discretion they need. It is common for plan sponsors to use forfeitures to cover permissible, reasonable plan expenses. However, the decision to use forfeitures to pay plan expenses is a fiduciary decision, subject to ERISA’s strict fiduciary duty rules. Before using forfeited assets to pay for plan expenses, employers should consider the following:

• Does your plan document permit reasonable expenses to be paid with plan assets, including those held in the forfeiture/suspense account?
• Does ERISA permit these expenses to be paid with plan assets? In other words, do the expenses relate to fiduciary duties, rather than “settlor” activities? Remember, when an employer establishes and designs a plan, it is acting as a “settlor.” Expenses associated with “settlor” activities cannot be paid from plan assets; the employer must pay them directly.
• Is the expense prudent, and is the amount reasonable?

How Recent Litigation is Shaking Things Up

Our team has been keeping a close eye on the uptick in plan forfeiture litigation, even highlighting several high-profile cases in our 2024 end-of-year caselaw roundup, including the Dimou v. Thermo Fisher Scientific Inc., et. al. and Jason Sievert v. Knight-Swift Transportation Holdings, Inc. cases.

As a refresher, in the Dimou case, the defendants were accused of impermissibly using plan forfeitures to reduce future employer contributions instead of using such funds to pay plan expenses. Judge Robinson granted the employer’s motion to dismiss on several grounds, including that the plan document gave the employer discretion to choose between paying reasonable expenses of the plan or reducing future contributions.

Relatedly, while the plan documents in Knight-Swift granted plan administrators broad discretion over how to use forfeited assets, the plaintiffs alleged that the company’s Form 5500 filings committed the company to use forfeited assets to cover administrative costs, instead of employer contributions. The court in Knight-Swift held the written plan document controlled over the external Form 5500 filings, and the case was dismissed earlier this year. 

Even in cases where the plan language expressly allows the employer to use forfeitures to reduce employer contributions, plaintiffs are getting creative. In the Ramseur et al v. LifePoint Health, Inc. et. al. case, plaintiffs alleged that the plan sponsor breached its fiduciary duty of loyalty by using forfeitures to reduce employer contributions under the plan instead of reducing administrative expenses. In other words, plaintiffs alleged that applying the forfeitures to future contributions placed the employer’s financial interests above those of the participants, thereby breaching the employer’s fiduciary duty of loyalty.

How Can Plan Fiduciaries Protect Themselves from Forfeiture Litigation?

Given the rise in litigation, it’s crucial for employers to be proactive. Here’s what employers and plan fiduciaries should do to better protect themselves:

• Review Plan Documents – Critically! First and foremost, employers should review their plan documents to ensure they permit the use of plan forfeitures to offset employer contributions and pay the plan’s reasonable administrative expenses. If a plan utilizes ordering rules (for example, forfeitures must first be used for reasonable administrative expenses and next to offset employer contributions), employers should carefully allocate forfeitures pursuant to such ordering rules in the plan, or amend the plan to broaden employer discretion for the use of forfeitures.
• Follow the Terms of the Plan. Once plan language is set, employers must follow the language of the plan to avoid the easiest type of plan forfeiture case: one in which the plaintiff can establish that the employer disregarded the plan’s terms.
• Remember ERISA’s Fiduciary Duties. If you choose to use plan forfeitures to pay plan expenses, you must carefully consider whether doing so aligns with ERISA’s fiduciary duties. Specifically, employers must analyze whether the expenses are reasonable, prudent, and in the best interests of plan participants. Thorough documentation of this decision-making process can be a lifesaver in the event of litigation (or regulatory investigation or audit).
• Timely Exhaustion of Forfeitures. Finally, make sure you have procedures in place to use or allocate forfeiture amounts within 12 months of the end of the plan year in which they are incurred, as required by the Code and ERISA.

The landscape of plan forfeiture litigation is evolving, making proactive compliance more critical than ever. By thoroughly reviewing your plan documents, adhering strictly to plan terms, satisfying ERISA’s fiduciary duties, and ensuring timely exhaustion of forfeitures, you can reduce the risk of dealing with a plan forfeiture issue.

If you would like assistance reviewing plan documents to ensure plan forfeiture compliance, please reach out to our benefits team.