A forfeiture arises when a participant leaves before becoming fully vested in employer contributions. The unvested portion is forfeited from their account — and what happens next is governed by the plan document and by timing rules that plans breach routinely, usually by doing nothing.
The plan document specifies the triggering point. Common approaches are forfeiture on distribution of the vested balance, or forfeiture after the participant incurs a specified break in service — often five consecutive one-year breaks.
Because the trigger is a plan design choice, it must be read rather than assumed. Plans administered on a general understanding of "when someone leaves" frequently forfeit too early or too late.
Permitted uses are set out in the plan document and typically include:
What forfeitures may not do is revert to the employer. They are plan assets.
This is the central compliance issue. Forfeitures are generally required to be used in the plan year in which they arise, or shortly thereafter as the plan document provides. They are not intended to accumulate indefinitely in a suspense account.
Yet accumulated forfeiture balances carried for several years are among the most common findings in plan examinations. The cause is almost always neglect rather than intent — nobody owns the task, the balance sits in a suspense account, and it grows quietly.
If your plan has a forfeiture balance older than the current plan year, that is a finding waiting to happen.
Where a participant is rehired and their prior service must be restored, previously forfeited amounts may also need to be restored to their account. Plans that treat every rehire as a new participant miss this, and the error compounds because it affects vesting going forward as well.
See calculating vesting service under a 401(k) plan for how service restoration works.
Where forfeitures reduce employer contributions, the reduction should be applied as the document directs and reflected accurately in the contribution calculation. Where they are reallocated to participants, the allocation formula in the document governs — and reallocation can have nondiscrimination implications that need testing.
If forfeitures have accumulated beyond the permitted period, correction generally involves allocating or applying them as they should have been in each year, consistent with the plan document. Where the amounts or the period are significant, take advice — the correction method matters, and self-correction has conditions.
Forfeiture handling is examined, and the examination looks at records rather than intentions. Keep, for each plan year, the opening forfeiture balance, amounts forfeited and by whom, amounts restored to rehired participants, amounts applied and to what purpose, and the closing balance.
Where forfeitures reduced employer contributions, the reconciliation between the contribution calculation and the forfeiture account should be retained alongside the contribution records. Plans that cannot demonstrate this linkage struggle to show that forfeitures were applied as the document requires.
Forfeiture balances accumulate because nobody is responsible for them. The recordkeeper reports the balance; the plan sponsor is responsible for directing its use; and in many organisations neither party treats it as their task.
Assigning explicit ownership to a named individual, with an annual review date, prevents almost every version of this problem. It is a fifteen-minute task once a year that prevents a finding that can take months to correct.
No. They are plan assets and must be used as the plan document permits.
Where the plan document permits and the expenses are reasonable plan expenses.
Treat it as a correction matter rather than allowing it to continue, and take advice where the amounts are material.
No. Elective deferrals are always fully vested.
See our retirement plan administration training for plan administration generally.
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