Forfeitures Accounts – The Next New Topic of ERISA Litigation Trends & Should You Be Concerned?

A handful of new ERISA litigation cases (including McManus v. Clorox Co., N.D Cal. No. 4:23-cv-05325) are taking aim at forfeiture accounts and trying to pull them into the never-ending list of ways in which retirement plan fiduciaries have purported to breach their fiduciary duty to plan participants.

The recent lawsuits argue that even though permitted by the plan document, it was a breach of fiduciary duty to exercise discretion to use the plan’s forfeitures to reduce company contributions, rather than to offset expenses of the 401(k) plan.

Acknowledging the plan permitted the actions, the plaintiffs still found fault suggesting the plan’s fiduciary had “consistently chosen to utilize the forfeited funds in the Plan exclusively for the Company’s own benefit, to the detriment of the Plan and its participants, by using these Plan assets solely to reduce Company contributions to the Plan.”

The IRS has endorsed the use of forfeitures by defined contribution plans to reduce employer contributions for decades (Rev. Rul. 84-156). The use is explicitly spelled out in recent proposed regulations which provide that forfeitures must be used to (1) pay plan administrative expenses, (2) reduce employer contributions, or (3) increase benefits under plan terms. Proposed to become applicable for plan years beginning on or after January 1, 2024,  see our prior blog post for more details about the proposed regulations.

The DOL has not issued specific guidance on this issue. Note, however, that the timing of these lawsuits coincides with a September 28, 2023 consent order and judgement that resolves a DOL complaint relating to forfeiture accounts.  As reported in a recent DOL news brief, the DOL filed a complaint in 2017 against a plan sponsor asserting that it failed to follow its own governing documents regarding the use of forfeiture funds for several of its 401(k) plans. The DOL alleged that “the 401(k) plans’ governing documents required defendants to use forfeiture funds to pay plan expenses, but instead, defendants used the forfeiture funds to reduce employer contributions to the plans. By doing so, the employer benefited by reducing its contributions to the plans, at the expense of plan participants who saw their plan account balances reduced by payments of plan expenses from plan assets and not from forfeitures. On Sept. 28, 2023, the judge issued a consent order and judgment ordering [the plan sponsor] to restore $575,000 to the plan participants who were harmed by defendants’ use of the forfeiture funds.”

It's unclear at this early stage whether the lawsuits will get any traction in court, but they and the DOL’s news brief are an important reminder to check in on your plan document provisions and procedures as they relate to the plan’s forfeiture account. Confirm what your company’s practice is with respect to the use of forfeiture amounts and make sure the plan document allows whatever that practice is. As always, your number one best practice is to follow your plan documents.

If you have any questions about your forfeitures accounts or the new regulations, please contact any of Graydon’s employee benefits team.

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