401(k) Forfeitures: How and When They Must Be Used

A 401(k) forfeiture is the unvested portion of employer contributions an employee leaves behind when they separate from service. The money stays in the plan, and the plan document controls how it can be put to work: to pay plan expenses, reduce employer contributions, or increase other participants' accounts. It can never revert to the employer, and proposed IRS rules require it to be applied within 12 months after the end of the plan year in which it occurs.

Even so, forfeitures have been the subject of more than 100 class action lawsuits. Plaintiffs argue that employers who tapped forfeitures to reduce their own contributions, instead of paying plan expenses, failed to act in participants' best interest, even when the plan document allowed that choice.

A plan document that spells out exactly how forfeitures will be applied is the best protection against that claim, and acting within IRS deadlines avoids sanctions. This guide explains how forfeitures arise and how to manage forfeiture balances to reduce participant objections and stay compliant.

What Is a 401(k) Forfeiture?

A forfeiture is the unvested part of a participant's account that they give up when they leave. Only employer contributions subject to a vesting schedule can be forfeited. Employer contributions that can be subject to vesting include:

• • Matching contributions in a traditional (non-safe harbor) 401(k) plan
  • Discretionary matching contributions in a safe harbor 401(k) plan
  • Profit sharing contributions in a traditional or safe harbor 401(k) plan
  • Qualified automatic contribution arrangement (QACA) safe harbor contributions, which can require up to two years of service for full vesting

Matching and profit sharing contributions can vest as slowly as a 3-year cliff or 6-year graded schedule (IRC §411(a)(2)(B)). Under a 6-year graded schedule, for example, an employee with three years of service is 40% vested. If that employee leaves with $10,000 of profit sharing in their account, $4,000 belongs to the employee and $6,000 becomes a forfeiture.

Some money in a 401(k) plan is always 100% vested and can never be forfeited:

• • Employee deferrals (pre-tax and Roth) and rollover contributions
  • Traditional safe harbor matching and nonelective contributions
  • Qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs)

When 401(k) Forfeitures Occur

A participant doesn't forfeit anything on their last day of work. Under IRS rules and most plan documents, the unvested balance is forfeited at the earlier of two events:

1. 1. Distribution: The participant receives a distribution of their entire vested balance.
   2. Five consecutive one-year breaks in service: A one-year break in service is generally a plan year in which the participant is credited with 500 or fewer hours of service, whether or not they're still employed. A former employee typically incurs a break each full plan year after leaving, and after five consecutive breaks, their unvested balance is forfeited even if they never take a distribution.

Many plan documents also include a deemed cash-out rule. A participant who leaves 0% vested is treated as having received a $0 distribution, so their unvested balance can be forfeited right away.

When Participants Become Fully Vested

Certain events make a participant 100% vested regardless of service, leaving nothing to forfeit:

• • Reaching the plan's normal retirement age
  • Death or disability, if the plan document provides for it
  • Plan termination or partial termination
  • A complete discontinuance of employer contributions

Partial terminations are the easiest to miss. When an employer lets go of 20% or more of plan participants in a plan year, even if it refills those positions, the IRS presumes a partial termination has occurred, and affected participants must be fully vested (Rev. Rul. 2007-43). Forfeiting their unvested balances anyway is a common operational error after layoffs or a business sale.

What Happens if a Former Employee Is Rehired

Forfeitures aren't always permanent. A participant who received a distribution and is rehired before incurring five consecutive one-year breaks in service generally can pay the full distribution back into the plan. If they do, the plan must restore the forfeited amount to their account (IRC §411(a)(7)(C)). Plans typically fund restorations from current forfeitures first, which is one more reason to track the forfeiture account carefully.

How 401(k) Forfeitures Can Be Used

Once a forfeiture occurs, the money moves to the plan's forfeiture account until it's spent or allocated. The IRS's proposed forfeiture regulations (88 FR 12282) permit three uses in a 401(k) or other defined contribution plan:

• • Pay plan administrative expenses
  • Reduce employer contributions
  • Increase other participants' benefits by reallocating forfeitures as an additional contribution

Your plan document controls which uses are available, and whether they're applied in a set order or at the plan sponsor's discretion. A plan can name just one use, but the IRS cautions that limiting the plan to one option can leave forfeitures unapplied by the deadline. A plan limited to reducing employer contributions, for example, has nowhere to put them in a year the employer contributes less than the forfeiture balance.

Paying Plan Expenses With Forfeitures

Forfeitures can pay reasonable plan expenses that would otherwise be charged to participant accounts, such as recordkeeping, third-party administration, investment advisory, and audit fees. They can't pay settlor expenses, which benefit the business rather than the plan, such as the cost of designing a plan or deciding whether to amend it.

If your business pays plan fees directly, forfeitures can pay future invoices instead. Reimbursing your business from forfeitures for fees it has already paid raises prohibited transaction concerns, so check with your provider first.

Reducing Employer Contributions With Forfeitures

Forfeitures can reduce any type of employer contribution, including matching, profit sharing, and safe harbor contributions, as well as qualified nonelective and qualified matching contributions (QNECs and QMACs). An employer that owes a $40,000 safe harbor match for 2026 and has $6,000 in its forfeiture account, for example, can apply $6,000 to reduce employer contributions and deposit $34,000.

Reallocating Forfeitures to Participants

Forfeitures can also be allocated to remaining participants as an additional employer contribution, under the allocation method in your plan document. Reallocation has side effects to plan for:

• • Reallocated forfeitures count as annual additions toward each participant's §415(c) limit ($72,000 for 2026).
  • They're included in the plan's nondiscrimination testing.
  • In a safe harbor 401(k), allocating forfeitures as a profit sharing contribution ends the plan's top-heavy exemption for that year (Rev. Rul. 2004-13).

Forfeitures Can Never Revert to the Employer

All three options keep forfeitures inside the plan. ERISA requires plan assets to be held for the exclusive benefit of participants and beneficiaries (ERISA §403(c)(1)), so forfeitures can never be returned to the business. And spending forfeitures on a purpose your plan document doesn't authorize is an operational failure, even if IRS rules would otherwise allow it.

The 12-Month Deadline for Using Forfeitures

Under the proposed regulations, a defined contribution plan must apply forfeitures no later than 12 months after the close of the plan year in which they were incurred:

The 12-month rule is the outside limit. Some plan documents require forfeitures to be cleared in the same plan year they occur, and the stricter plan deadline controls.

Proposed Regulations and the Transition Rule

The IRS proposed the forfeiture regulations in February 2023. They aren't final yet, but as proposed they would apply to plan years beginning on or after January 1, 2024, and plan sponsors may rely on them.

A transition rule covered older balances: forfeitures incurred before 2024 are treated as incurred in the first plan year beginning on or after January 1, 2024. For calendar-year plans, that made December 31, 2025, the deadline to clear any pre-2024 backlog. A plan still holding those forfeitures likely has an operational failure to correct.

401(k) Forfeiture Lawsuits: What Plan Sponsors Should Know

Following your plan document and the 12-month deadline keeps your plan in line with IRS rules. The lawsuits raise a different question: when a plan gives the employer a choice, did the employer choose in participants' best interest? Since September 2023, participants have filed more than 100 class actions on that question. Nearly all target large employers, but the plan language they challenge is common in small business plans, too.

What the Lawsuits Claim

The typical complaint involves a plan that lets the employer either pay plan expenses or reduce employer contributions with forfeitures. Plaintiffs argue that reducing company contributions, while participants paid plan fees from their own accounts, put the employer's interests first. The legal theories include:

• • Breach of the duties of loyalty and prudence under ERISA §404(a)
  • Prohibited transactions, by directing plan assets to the employer's benefit, under ERISA §406
  • Violation of the anti-inurement rule under ERISA §403(c)(1)

The lawsuits don't claim that IRS rules prohibit offsetting employer contributions with forfeitures. The proposed regulations expressly allow it. The claim is that choosing that option, when the plan allows others, is a fiduciary decision that must favor participants.

How Courts Have Ruled

So far, most courts have sided with employers:

• • Motions to dismiss: Through 2025, 26 of 31 written rulings on motions to dismiss (more than 80%) favored plan sponsors, according to a Mayer Brown analysis.
  • First appellate decision: In Matula v. Wells Fargo (8th Cir. 2026), the court upheld dismissal because the plaintiff hadn't shown an injury to his own account. It didn't decide whether the forfeiture practice itself was lawful.
  • Pending appeals: Appeals are pending in the Third, Fourth, and Ninth Circuits, including Hutchins v. HP, which the Ninth Circuit heard in May 2026.
  • The DOL's position: The Department of Labor has filed amicus briefs supporting employers. It argues that offsetting employer contributions with forfeitures doesn't, by itself, violate ERISA when the plan document permits it.

Employers haven't won every round. A handful of cases have survived motions to dismiss, and some employers have settled. In October 2026, W.W. Grainger agreed to pay $2.85 million to settle a forfeiture class action, pending court approval.

What This Means for Small Business Plans

Forfeiture lawsuits target large plans because potential damages grow with plan assets. For a small business, the more likely problem is an IRS operational failure, such as forfeitures left unused past the deadline. Still, the litigation offers lessons for any plan sponsor:

• • Read your plan's forfeiture provision. Know whether it dictates how forfeitures are applied or leaves the choice to you.
  • Consider removing the discretion. A plan document that specifies how forfeitures will be spent, such as first to pay plan expenses and then to reduce employer contributions, generally turns the choice into a plan design decision rather than a year-by-year fiduciary one. Talk with your plan provider before amending.
  • Document your decisions. If your plan gives you discretion, record how you applied forfeitures each year and why.
  • Apply forfeitures on time. Review the forfeiture account with your provider before each plan year ends.
  • Keep your summary plan description current. Make sure it accurately describes how forfeitures are handled.

How to Correct Unused or Misused Forfeitures

If your plan has missed the deadline, or spent forfeitures in a way the plan document doesn't allow, it has an operational failure: the plan wasn't operated according to its written terms. Left uncorrected, operational failures can threaten a plan's tax-qualified status. The IRS's Employee Plans Compliance Resolution System (EPCRS) provides the fix, and many failures can be self-corrected without an IRS filing or fee.

The correction generally puts the plan where it would have been if forfeitures had been handled correctly:

• • Unused forfeitures: Apply them as the plan document required for the year they should have been applied. If that means a reallocation, participants who would have shared in the forfeitures receive allocations adjusted for earnings. That can require several years of census and compensation data, including data for former employees.
  • Improperly applied forfeitures: If forfeitures paid for something the plan doesn't allow, the employer generally restores the amount to the plan, with earnings.

Your recordkeeper or third-party administrator can help you choose and document a correction method, and set up a process so the failure doesn't recur.

Final Thoughts

Three rules govern 401(k) forfeitures: apply them only as your plan document allows, apply them within 12 months after the end of the plan year in which they occur, and never let them revert to the business. The lawsuits have mostly failed, but they've shown that vague plan language and idle forfeiture balances invite scrutiny. A clear forfeiture provision, an annual review of the forfeiture account, and documented decisions protect your plan from both IRS trouble and plaintiffs' attorneys.

At their core, forfeiture lawsuits are fee lawsuits: plaintiffs argue forfeitures should have lowered what participants pay. Low, transparent plan fees take much of the force out of that argument.

If you're not sure what your plan's forfeiture provision says, or you want a provider that publishes its fees, talk with our team or request a quote. Our guide to 401(k) vesting schedules is a good next read, too.