What Is a 401(k) Forfeiture Account?
Understand 401(k) forfeiture accounts: where unvested employer contributions go and how these funds are managed and utilized within retirement plans.
A 401(k) forfeiture account holds unvested employer contributions. When an employee leaves a company before fully earning the right to employer-provided funds, the unvested portion moves into this account.
How Funds Enter a Forfeiture Account
Funds enter a forfeiture account due to “vesting” in employer contributions. Vesting refers to an employee’s ownership of employer 401(k) contributions. While an employee’s own contributions are always 100% vested, employer contributions often have a vesting schedule.
If an employee terminates employment before becoming fully vested, the unvested portion of employer contributions is forfeited. For example, if an employee is 40% vested and leaves, the remaining 60% is forfeited. Common vesting schedules are “cliff vesting” and “graded vesting.” Cliff vesting grants 100% ownership of employer contributions after a specific period, typically up to three years, with 0% vesting before then. Leaving before this period forfeits all employer contributions.
Graded vesting allows employees to gradually gain ownership of employer contributions over time, often up to six years. For instance, an employee might be 20% vested after two years, increasing incrementally to 100%. If an employee leaves before full vesting, they retain the vested percentage, and the unvested portion is forfeited.
Permissible Uses of Forfeiture Funds
Once funds are in a forfeiture account, plan sponsors must use them for specific, IRS-approved purposes that benefit the plan or its participants. These funds cannot be returned to the employer for profit.
A primary use of forfeiture funds is to offset future employer contributions, such as matching or profit-sharing. This reduces the employer’s direct cash outlay while fulfilling plan obligations. Forfeitures can also pay reasonable administrative expenses, including record-keeping, audit fees, or legal services.
Forfeiture funds may also be reallocated to other participants, though this is less common and depends on plan document provisions. Some plans permit using forfeitures to restore previously forfeited account balances for rehired employees, if conditions are met. All uses must be outlined in the plan document and align with fiduciary duties under ERISA.
Managing Forfeiture Accounts
Proper management of 401(k) forfeiture accounts is essential for plan sponsors to maintain compliance with IRS and DOL regulations. This includes meticulous record-keeping and accounting. Forfeited funds cannot accumulate indefinitely and must be used timely.
The IRS requires forfeitures be used no later than 12 months after the end of the plan year in which they occurred. For instance, funds forfeited in 2024 must typically be used by December 31, 2025, for a calendar-year plan. Failure to use forfeitures within this timeframe can lead to operational failures, jeopardizing the plan’s qualified status and incurring penalties.
Plan sponsors should consult their plan document for specific rules on using forfeitures, as these dictate how and when funds must be disbursed. Regular review of forfeiture account balances and timely usage are important practices. The IRS has provided transition rules, allowing plan sponsors to address previously accumulated forfeitures by a specific deadline, such as December 31, 2025, for forfeitures incurred before January 1, 2024.