A forfeiture is the unvested employer contributions an employee leaves behind when they leave before vesting. It stays in the plan and gets used to pay the plan's expenses or to fund employer contributions to the people still there.
Forfeitures can be used for three purposes: paying plan administrative expenses, reducing employer contributions, or increasing benefits in other participants' accounts. Your plan document decides which of the three are available to you.
Forfeitures cannot sit in the account indefinitely. Under proposed IRS regulations, a forfeiture has to be used by the end of the plan year following the plan year in which it was incurred.
If your plan document permits more than one use and does not say which comes first, somebody has to choose. Courts have agreed that making that choice is a fiduciary act.
Three things to do: read what your plan document permits, ask what is in the forfeiture account right now, and write down the reasoning behind whichever use you apply.
What Is a 401(k) Forfeiture?
If your plan puts employer contributions into participant accounts on a vesting schedule, an employee has to stay a set number of years before those contributions are fully theirs. Someone who resigns at two years under a five-year graded schedule keeps their own contributions plus the share of the employer contributions they have vested in, and the rest stays in the plan.
That unvested remainder is a forfeiture. It stays in the plan, in whatever account your plan uses to hold forfeitures, until it is applied to one of its permitted uses.
The money in that account belongs to the plan, not to the company. ERISA requires plan assets to be held in trust for participants and spent only on their benefits and the plan's reasonable expenses. That is why the company cannot simply take the balance back, and why there are only three things the plan can do with it.
How Can 401(k) Forfeitures Be Used?
Forfeitures in a defined contribution plan can be used for one or more of three purposes, as specified in the plan:
Paying plan administrative expenses. Recordkeeping, compliance testing, audit fees, and similar operating costs. If participants are currently paying those costs out of their accounts, forfeitures can cover them instead. Knowing what your plan's all in cost tells you how much that would be worth to them.
Reducing employer contributions. The company uses the forfeiture account to cover part of its match or profit-sharing obligation instead of funding the whole amount with new money.
Increasing benefits in other participants' accounts. The money is divided among remaining participant accounts according to the formula the plan specifies.
Reducing employer contributions sometimes sounds like the company taking the money back. It isn't. The money stays in the plan and still lands in participant accounts. What changes is that the company funds less of that year's contribution with new money.
These three uses are not new. They have been the accepted treatment for defined contribution plans since the Tax Reform Act of 1986, and proposed IRS regulations issued in February 2023 restate them.
When they have to be used
The proposed regulations set one deadline: a forfeiture has to be used within 12 months after the close of the plan year in which it was incurred. For a calendar-year plan, that means a forfeiture from one year has to be used by the end of the next. The regulations apply to plan years beginning on or after January 1, 2024, and taxpayers may rely on them for earlier periods.
Why permitting only one use is risky
The IRS gives this example in the proposed regulations:
• Your plan document says forfeitures may be used solely to pay plan administrative expenses.
• The plan year produces $25,000 in forfeitures.
• The plan only incurs $10,000 in administrative expenses before the deadline.
• The remaining $15,000 has no permitted use, so the plan has an operational failure.
An operational failure means the plan was not run the way its own document requires. Most can be self-corrected without contacting the IRS or paying a fee, but the fix takes work and has to be documented. Amending the document to permit more than one use avoids the problem entirely.
Who Decides How Forfeitures Get Used?
Your plan document answers this first. If it names one use, that is the answer, and the only remaining question is whether the plan is doing it. If it sets an order of priority, follow the order.
The harder case is a document that permits two or three uses and says nothing about which comes first. Someone then has to choose, and courts have agreed that where the plan gives that discretion, exercising it is a fiduciary act rather than a business decision. It carries the duty to act in the interest of participants and the duty to follow the plan's terms. That makes the choice something to reason through and recordrather than a routine instruction to the recordkeeper.
Participants have been suing over that choice since 2023, arguing that a sponsor who always applies forfeitures to reduce its own contribution is putting the company ahead of the plan. Courts have largely sided with the sponsors, and the pattern in those decisions is straightforward: the plan document said what forfeitures could be used for, and the sponsor did what it said.
Documenting the choice is worth doing regardless of the litigation. The IRS expects plan administrators to keep records showing the plan was run correctly, and the proposed regulations say those records include how forfeitures were used.
What Should a Plan Sponsor Do About Forfeitures Now?
Three things, and none of them requires a lawyer to start.
Read the forfeiture provision in your plan document. Find out which uses are permitted, whether an order is specified, and when the document says forfeitures have to be applied. If it permits only one use, ask your TPA what it would take to amend it. The Supreme Court has held that changing a plan document is a business decision rather than a fiduciary one, so the committee is not exercising discretion over plan assets in making it.
Ask your recordkeeper for the current balance and the plan year each amount was incurred in. Anything past its deadline needs attention now, and the balance belongs on a recurring agenda rather than turning up at year end.
Record the decision. Write down which uses your plan document permitted, which one you applied, and the reasoning. Your recordkeeper carries out the instruction, but the choice behind it stays with you.
All of this comes down to two things: knowing what your plan document permits, and having a record that shows you followed it.
Plan Sponsor FAQs
The IRS runs a correction system for exactly this, and an unused forfeiture balance is the kind of failure it is built for. Self-correction generally requires no filing and no fee, though it is only available to a sponsor that already had practices and procedures designed to keep the plan compliant. Having a plan document is not enough on its own. Acting before an IRS examination begins also matters, because examination closes off most of the options. Your TPA or ERISA counsel can confirm which path fits.
Start by finding out which plan year each amount came from, then check each one against the deadline. Anything past it is a correction matter. Ask your recordkeeper or TPA for that breakdown, and expect it to take some digging if the plan has changed providers.
You choose, and because you are choosing, you document. Look at what each of the permitted uses would mean for your participants and for the plan, decide, and write down the reasoning. Some sponsors adopt a written forfeiture policy so the same reasoning does not have to be rebuilt every year, which is worth considering as long as the policy is reviewed rather than left to run on its own.
Your plan may have to restore the amount they forfeited, depending on how they left and how long they were gone. The plan document sets those conditions, so confirm them before applying a balance to something else.
Legal Information Institute, ERISA Title I, Part 4, Fiduciary Responsibility (29 U.S.C. §§ 1101–1114) — https://www.law.cornell.edu/
Mayer Brown, The Current State of the Law in ERISA Forfeitures Cases (July 2025) — https://www.mayerbrown.com/
Important Disclosures
First Hill Trust Company is a Washington State-chartered trust company. Investment advisory services are provided by BAC Capital Advisors, an SEC-registered investment adviser and a wholly owned subsidiary of First Hill Trust Company. Registration does not imply a certain level of skill or training. This article is educational. Neither First Hill Trust Company nor BAC Capital Advisors is acting as ERISA counsel or tax counsel to any plan or plan sponsor, and nothing here replaces advice from qualified counsel about your own plan.
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