401(k) plan sponsors are seeing a string of lawsuits challenging their use of forfeitures to offset matching contributions. In the most recent suit, plaintiffs claimed that a 401(k) plan sponsor violated its fiduciary duties to participants by using forfeitures to offset employer contributions rather than to reduce plan administration expenses. This lawsuit, like others, alleges that these actions breached fiduciary duties of loyalty and prudence, violated ERISA’s anti-inurement provision, and constituted prohibited transactions.
Forfeitures arise when the employment of a plan participant terminates before the participant’s plan account becomes fully vested. For decades, many plan sponsors have used forfeitures in the same manner as the employers involved in the lawsuits. This practice is supported by a long-standing IRS regulation1 permitting plan sponsors to allocate forfeitures to reduce the employer’s future contributions. More recently proposed regulations explicitly allow employers to choose whether to use forfeitures to reduce employer contributions or offset plan administrative expenses.
Nearly all of the lawsuits involving forfeitures have been filed by a single law firm in various federal district courts in California. Because the legal theories posited in the suits are novel and will be subject to significant challenges, this type of lawsuit has not yet become widespread. However, it is prudent for plan sponsors to monitor these lawsuits because, if they gain any traction, other plaintiffs’ firms may begin filing similar actions throughout the country.
Thus far, two courts have rules on motions to dismiss the forfeiture cases. In May 2024, the first district court to issue a decision denied the defendants’ motion to dismiss, finding the plaintiffs’ allegations of breach of fiduciary duties to be plausible and allowing the lawsuit to proceed.2 More recently, a second district court found the plaintiffs’ theory in the case to be implausible because it asserted that ERISA requires plan administrators to always apply forfeitures to pay administrative expenses. The court therefore dismissed the case without prejudice (which leaves open the possibility that the plaintiffs could refile the case using a different theory).3
In addition to monitoring the current lawsuits, plan sponsors can take proactive measures to put themselves in the best position possible in the event these actions become widespread. Among other things, sponsors should review their plan documents to ensure that their actions with respect to forfeitures are consistent with applicable plan provisions. Also, for plan sponsors that use forfeitures to reduce employer contributions, changes to plan provisions governing the disposition of forfeitures may be prudent depending on how such provisions are currently drafted.
