Forfeitures

What forfeitures are

When an employee leaves with a partly vested balance, the unvested portion of the employer’s contributions is forfeited, usually when they take a distribution or after five consecutive one-year breaks in service. The money moves to a forfeiture account inside the plan. It never goes back to the employer.

A 401(k) plan can generally use forfeitures in three ways, as its document allows:

1. Pay reasonable plan administrative expenses.

2. Reduce employer contributions, such as a future match.

3. Allocate them to participants as an additional contribution.

Why it matters to employers

Forfeitures have to be used on time. Proposed IRS regulations from February 2023 would require a defined contribution plan to use them no later than 12 months after the close of the plan year in which they arise. The rule is not final, but the IRS has long treated unused balances that sit for years as an operational failure. Forfeiture practices have also been the subject of recent lawsuits against large plan sponsors, so follow the document exactly.

Example

Three employees leave in 2026 and forfeit $9,000 in unvested match. The plan document says forfeitures reduce employer contributions. The employer applies the $9,000 against its 2027 match deposits, well inside the 12-month window.

Common mistakes

• Letting a forfeiture account build up for several years.

• Using forfeitures in a way the plan document does not list.

• Forfeiting too early or too late compared with the timing in the document.

• Failing to restore a forfeited balance when a rehired employee qualifies to have it restored.