Forfeitures are a routine, but often misunderstood, feature of all qualified retirement plans. While they may seem like a minor administrative detail, how forfeitures are handled can directly impact employer contribution costs, participant balances, and overall plan compliance. Recent regulatory attention has also made forfeitures a renewed focus area for the DOL and the IRS.
What Are Forfeitures, Anyway?
Forfeitures are generated when a plan participant is terminated before becoming fully vested in their employer contributions, like matching or profit-sharing contributions. The nonvested portion of those contributions is forfeited and remains in the Plan until they’re used for a permissible purpose, which will be covered below. It’s important to note that all employee contributions are always 100% vested and cannot be forfeited under any circumstances. Forfeitures are most commonly generated when participants terminate early or when small balances are cashed out of the Plan and are typically stored in a suspense account to be tracked separately.
A Plan’s vesting schedule has a direct impact on the amount of forfeitures it generates year to year. Most plans implement either cliff vesting or graded vesting – see below for an example of each. Under cliff vesting, participants become fully vested after a specified period of service, while under graded vesting, ownership of employer contributions increases incrementally over time. Since forfeitures represent the nonvested portion of participant balances, you’ll find an inverse relationship between a vesting schedule and the percentage of balances that could potentially be forfeited upon distribution – a 20%-per-year over six years vesting schedule would see a potential forfeited balance start at 100% upon hiring and drop by 20% as each period of service is completed.
| Six-Year Graded Vesting Schedule | Three-Year Cliff Vesting Schedule | |||
| Years of Service | Vested Percent | Years of Service | Vested Percent | |
| <1 | 0% | <1 | 0% | |
| 1 | 0% | 1 | 0% | |
| 2 | 20% | 2 | 0% | |
| 3 | 40% | 3 | 100% | |
| 4 | 60% | 4 | 100% | |
| 5 | 80% | 5 | 100% | |
| 6 | 100% | 6 | 100% | |
The six-year grading schedule above represents the maximum amount of time a participant can wait until they’re fully vested, according to IRS limits for graded vesting. The three-year cliff schedule is the maximum under cliff vesting. Plan provisions can always be more generous, but never more restrictive than these schedules. That means that any Plan, not just safe-harbor plans, can have immediate vesting for employer contributions – a.k.a. no forfeitures at all – so long as the plan document allows for it. It’s also key to note that if a terminated employee is rehired following a five-year break in service (or a break in service greater than their pre-break service), they can lose out on whatever vesting they had accumulated prior to termination. Even an active employee that works less than 500 hours for five consecutive years can suffer the same fate, see our previous blog Long-Term, Part-Time Employee Administration for an in-depth look at LTPT regulations. Vesting can be such a nuanced subject that it deserves its own article!
How to Use Forfeitures: What’s Permissible and What’s Prohibited
The plan document sets the guidelines for how forfeitures may be used in a Plan, so it’s always best practice to continually review it and make sure all your favorite permissible uses are allowed in the first place. For most plans, the typical uses of forfeitures are: (1) paying reasonable plan administrative expenses, (2) reducing or offsetting future employer contributions, and (3) reallocating amounts to participant accounts. From a practical standpoint, forfeitures are used as a cost-management tool. For example, if an employer typically makes a $100,000 annual profit-sharing contribution at the end of the year and has $15,000 in forfeitures, the Plan may allow the employer to contribute only $85,000 in cash and use the forfeitures to make up the difference. Alternatively, they could be used to pay recordkeeping fees, audit fees, third-party administrator fees, or any other type of expenses incurred to administer the Plan.
In some cases, plan sponsors like to have the option to reallocate forfeitures to participants as additional contributions based on a formula spelled out in the plan document (e.g., pro rata based on compensation). While this does sound like a great way to retain employees, it’s best to keep an eye on how these reallocated contributions might push certain participants beyond 415(c) limits. In more specialized situations, forfeitures can even be used to restore previously forfeited balances for employees that are rehired, so long as that’s within the Plan’s restoration period (which is spelled out by, you guessed it, the plan document). Even further, forfeitures can be used to fund corrective contributions like qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs) as long as the Plan permits.
Because forfeitures are considered plan assets, they must be used solely for the benefit of plan participants and beneficiaries and can’t be diverted for the benefit of the employer’s general business. Under no circumstances can an employer transfer forfeited balances into the company’s operating account or use them to pay expenses outside of administering the Plan. It’s also not good practice to allow forfeited balances to accumulate in the suspense account year after year. The IRS has firmed its guidance on the timing of when forfeitures need to be used, which is no later than 12 months after the close of the plan year in which they were incurred. Particular relief was granted during the 2025 plan year, when the IRS allowed employers to treat all forfeited balances accumulated prior to January 1, 2024 as if they were first forfeited in the 2024 plan year, essentially giving all plan sponsors a head start in getting compliant.
2025 – The Year Forfeitures Went Under the DOL’s Microscope
After reading the permissible uses of forfeited balances, would you be surprised to hear that over 30 cases have been filed since May 2025 alleging that employers that use forfeitures to offset employer contribution obligations are actually breaching their fiduciary duty of loyalty and prudence under ERISA? Starting back in September 2023, over 80 class action lawsuits have been filed claiming that employers are sacrificing their plan participants’ interests by using forfeitures to offset employer contributions instead of offsetting plan administrative expenses that are ultimately being charged to participant accounts. This theory basically states that by reducing what employers owe in future contributions, they’re essentially putting their own financial interests ahead of their participants’. More than 30 cases were settled in 2025, with average settlements exceeding $3 million.
The good news? The DOL has primarily taken the side of the plan sponsors in most of these cases, granting motions to dismiss in 25 of the 30 cases mentioned above. Amicus briefs have been filed supporting defendants in four appeals, explaining in all four that as long as the use of forfeitures is allowed in the plan document, there is no breach of fiduciary duty when offsetting employer contribution obligations. This has reinforced a key legal distinction: deciding how to a fund a Plan is a settlor function, a plan design decision, not a fiduciary function, which means it falls outside the reach of ERISA’s fiduciary duty rules altogether.
Despite the rosy picture the DOL has painted with its amicus briefs, there continues to be large settlements paid out to plaintiffs in these cases. In other words, a favorable regulatory environment doesn’t make you lawsuit-proof. The most practical steps you can take today are: first, make sure your plan document explicitly provides for multiple allowed uses of forfeitures so fiduciaries have documented discretion; second, when your plan committee makes a decision about how to apply forfeitures in a given year, document the reasoning behind that decision in committee minutes; and third, make sure forfeitures are being used within the 12-month period after plan year-end deadline to avoid creating a separate operational compliance headache on top of any litigation exposure. Furthermore, some plan providers outline the specific order in which forfeitures may be used: first, to pay administrative expenses, then to offset employer contributions, then for additional allocations. Following a prescribed schedule like this can prove to any suspecting eyes that loyalty to the participants’ interests comes before any other considerations. The paper trail you create today is the best defense tomorrow. Making sure there is foolproof evidence documenting the justification for forfeiture usage and its compliance with the fiduciary duty of loyalty to plan participants is best practice in staying out of the DOL’s iron sights.
