How Insurance Brokers Can Help Clients Manage 401(k) Forfeitures Effectively 4 min read

In California, many employers offer a 401(k) retirement plan to their employees. Often, these plans include a vesting schedule—a timetable that determines when employees fully own the employer’s contributions. If an employee leaves before being fully vested, the unvested portion becomes a forfeiture. Managing these forfeitures 401k wisely is important for businesses’ financial health and legal compliance. Here’s how insurance brokers can support clients in California to handle forfeitures well.

What Are Forfeitures 401k, and Why They Matter

• Definition: Forfeitures happen when an employee hasn’t met the vesting requirements and exits the company—those unvested employer contributions revert back to the plan’s forfeiture account.
  
• Scope in California: Many plans use graded vesting (e.g., 20% vested after 2 years, 100% after 6). With high employee turnover—especially in industries like retail—many forfeitures can build up.
  
• Legal use: According to IRS, forfeitures must be used for three purposes: to reduce employer contributions, pay plan expenses, or add to participants’ accounts.

The Legal Landscape: ERISA & California Law

Federal Framework (ERISA)

• ERISA compliance: California employers must follow ERISA (Employee Retirement Income Security Act), which governs retirement plans nationally. It doesn’t prohibit using forfeitures to reduce employer contributions if permitted in plan documents and IRS guidance.
  
• Court rulings:
  
  • Hutchins v. HP (N.D. Cal.) dismissed claims, finding that using forfeitures consistent with plan terms doesn’t violate ERISA.
    
  • Perez‑Cruet v. Qualcomm (S.D. Cal.) denied dismissal, finding potential ERISA breaches where participants allege reduced benefits.
    
• Outcome: California courts are split. Some allow litigation to proceed; others side with employers using discretionary plan language .

Why This Matters for California Employers

1. Lawsuit risk: Over 30 lawsuits nationwide claim misuse of forfeitures. Two in California alone demonstrate legal uncertainty.
   
2. Operational mistakes: IRS rules require forfeitures to be used no later than the end of the next plan year—failure is an operational error that can be costly.
   
3. Financial value: Forfeiture balances, if managed correctly, can offset expenses, reduce contributions, or even benefit participants.

The Role of Insurance Brokers

A. Reviewing Plan Documents

Brokers should:

• Examine plan language to verify whether it permits reducing employer contributions, paying expenses, or reallocating funds.
  
• Ensure clarity in discretionary authority—who decides how to use forfeitures—to reduce legal risk.

B. Compliance Check

• Timeliness: Use forfeitures within the IRS deadline—typically by the end of the next plan year.
  
• IRS transition rule: Forfeitures from plans before Jan 1, 2024 must be used by Dec 31, 2025 .
  
• Brokers can help maintain documentation, track deadlines, and avoid operational failures.

C. Mitigating Litigation Risk

• Discretion clarity: Document how decisions are made, showing fiduciary diligence.
  
• Plan design advice: Recommend plan language revisions like mandatory forfeiture usage or clear procedures to reduce disputes .
  
• Fiduciary support: Educate clients on balancing duties of loyalty and prudence when managing funds, especially in light of mixed legal precedents.

D. Financial Optimization

• Cost savings: Where allowed, forfeitures can reduce future employer contributions, freeing up cash flow.
  
• Fee management: Use forfeitures to pay administrative expenses—fees that otherwise would burden the company or participants.
  
• Participant benefits: Optionally, rollover funds to participant accounts or repay prior forfeitures for rehires.

Practical Examples & Case Studies

Example 1: Medium‑sized California Tech Firm

• Background: 80 employees with graded vesting.
  
• Situation: $50,000 in forfeitures over two years.
  
• Broker strategy:
  
  • Checked plan allows matching offset and fee payment.
    
  • Allocated $30,000 to pay admin fees, $20,000 toward employer contributions.
    
  • Documented decisions and deadlines.
    
• Outcome: No operational errors; reduced contributions; safer audit risk profile.
  

Example 2: Restaurant Chain in Los Angeles

• Challenge: High turnover, significant forfeitures.
  
• Broker role:
  
  • Recommended plan amendment requiring automatic use of forfeitures yearly.
    
  • Set internal go-live for deadline tracking and annual review.
    
• Outcome: No surplus build-up, transparent process, reduced liability.

Why This Matters to Californians

• Protect employees: Proper use of forfeitures safeguards participant benefits and furthers retirement security.
  
• Cost efficiency: Especially in high-turnover industries like hospitality, smart forfeiture use can reduce business costs.
  
• Legal compliance: California employers must comply with ERISA and IRS rules—missteps can bring audits or lawsuits here.
  
• Peace of mind: With clear processes and broker guidance, clients can focus on business while knowing plans are compliant.

Conclusion

Managing forfeitures 401k is more than a technical task—it’s a fiduciary responsibility and compliance safeguard. For California businesses, mishandling forfeitures can lead to costly operational failures or litigation. Insurance brokers play a vital role: reviewing plan terms, advising on deadlines and usage, reducing financial burdens, and documenting carefully.

By working with brokers early, clients can turn forfeitures from a compliance challenge into a strategic advantage—supporting both their bottom line and participant retirement outcomes.