4 Options for Allocating 401(k) Plan Forfeitures

Greg Addison | 6-28-2017

Virtually all 401(k) plans have some level of forfeitures, which are non-vested employer contributions to terminated employees. There are multiple ways retirement plan forfeitures can be used, and for anyone serving in a fiduciary capacity, it is critically important to understand your options.

Guidance provided by the Internal Revenue Code (IRC) and the Internal Revenue Service (IRS) suggests the following four approaches can be used when allocating retirement plan forfeitures:

  1. Can be used to subsidize future employer contributions
  2. Can be used to pay reasonable retirement plan expenses
  3. Can be allocated to remaining plan participants as additional contributions, or
  4. Can be used to restore previously forfeited participant accounts

1. Subsidize Future Employer Contributions

When plan sponsors use forfeitures to subsidize or reduce future employer contributions, these forfeitures can satisfy some, or all, of the employer contribution funding instead of using new employer money to fund the retirement plan.

This option is commonly used in plans that have employer contributions as a feature.

2. Pay Reasonable Retirement Plan Expenses

There are expenses (e.g., record keeping or TPA services) that are incurred when operating the retirement plan. Forfeitures can be used to cover those expenses. Doing so creates a less expensive plan for participants. 

3. Allocated to Remaining Plan Participants

Forfeitures can also be allocated to remaining plan participants (assuming the plan document allows for it) as an additional employer contribution. This approach creates the potential for accelerated retirement plan growth for participants who remain with the company. 

4. Used to Restore Previously Forfeited Participant Accounts

The fourth option allows certain rehired participants who repay plan distributions to buy back previously forfeited balances. In this case, the plan sponsor may reinstate previously forfeited amounts using available forfeitures. 

Since forfeitures from 401(k) retirement plans can be used in several different ways, it’s important to have a sound fiduciary process in place for using forfeitures. It is mandatory that your practice follows the plan document. 

Lastly, the plan sponsor serves as the primary fiduciary. As with all other decisions involving the plan, the plan sponsor has the fiduciary duty to act solely in the best interests of the retirement plan participants and their beneficiaries when implementing a forfeitures strategy.

This information is not intended to provide specific tax, legal, or business advice and may not be relied upon for the purpose of avoiding any tax penalties. Lewer Financial Advisors is a multi-state registered investment advisor domiciled in Missouri. Lewer Financial Advisors is a member of the Lewer group of companies.

Greg Addison

Author: Greg Addison

Greg Addison is the Senior Vice President of Lewer Financial Services, LLC. Lewer Financial Advisors is a corporate Registered Investment Advisor, specializing in both personal wealth management and institutional retirement plan consulting for the individual investors, business owners, dealers, retailers, and franchisees who know The Lewer Companies well.