- May 1, 2026
As you probably know, forfeitures may occur in a retirement plan when a plan sponsor makes employer contributions (such as a match or profit share) and subjects them to a vesting schedule. If an employee terminates prior to achieving 100 percent full vesting under such schedule, the non-vested portion of the employer contributions are “forfeited”. When forfeitures accrue, they are then allocated to a separate plan account which is available to be used by the plan sponsor for certain limited purposes.
There are only three permissible ways that forfeitures may be used by the plan sponsor. They may be: 1) used to pay reasonable plan administration fees; 2) used to reduce employer contributions; or 3) reallocated to eligible participants as an additional employer contribution. However, whichever method of using forfeitures is selected by the plan sponsor, it must be explicitly authorized within the plan document of the plan.
According to the Internal Revenue Service (“IRS”), forfeitures in a defined contribution plan must be used no later than 12 months after the end of the plan year in which the forfeitures arose. For example, any forfeitures that occur due to an employee’s termination of employment in 2026 generally would need to be utilized in one of the three permissible manners listed above by no later than the end 2027.
The IRS considers any failure to abide by this timeline to be a compliance failure. Consequently, prompt utilization of forfeitures is an issue that should be reviewed by plan sponsors at least once annually in order to avoid having any problems. Notwithstanding, many plan sponsors inadvertently fail to honor this timing obligation and, as a result, their plans have compliance issues that should be addressed.
Although beyond the scope of this article, numerous participant lawsuits have recently been filed challenging the proper disposition of forfeitures. However, since those cases are still working their way through the legal system, it remains to be seen if they will have a significant impact on the utilization of forfeitures. Thus, until such time that any additional guidance becomes available from those lawsuits, it remains important to ensure that the terms of the plan document are followed regarding the permissible use of forfeitures.
We hope that this article helped you to better understand this topic and encourages plan sponsors to comply with these rules. However, please be advised that this article is not intended to serve as financial, tax or legal advice so it should not be construed as such. If you have questions about this topic, we strongly urge you to further discuss it with a qualified retirement plan professional. For more information about this topic, please contact our marketing department at 484-483-1044 or your administrator at Legacy.