If forfeitures are little more than an afterthought in managing your 401(k) plan, you are not alone.
401(k) forfeitures are one of those quiet plan mechanics that can create outsized compliance issues when plan sponsors misunderstand—or worse, ignore them.
Let’s break it down.
So, what are forfeitures, exactly?
Briefly, they are non-vested employer contributions that participants leave behind when they terminate employment.
👉 Employee contributions? Always 100% theirs.
👉 Employer contributions? Subject to the vesting that your plan provisions determine—and that’s where forfeitures come into play.
Some plans have 100% vesting in their employer contributions. However, if that is not the case for your organization, when someone leaves before they’re fully vested, the unvested portion doesn’t disappear—it moves into a plan-level forfeiture account.
And here’s the key point:
That money must stay in the plan and plan sponsors must use it for the benefit of participants—not the employer’s general business operations.
How can forfeitures be used?
The IRS gives plan sponsors three primary options (and your plan document dictates which applies):
- Offset future employer contributions
- Pay reasonable plan expenses
- Reallocate to participant accounts
Simple enough in theory. But in practice? This is where things start to drift.
Where plan sponsors get stuck
1. The “set it and forget it” trap
Forfeitures aren’t meant to sit indefinitely. Most plans require that plan sponsors use them within a defined timeframe—and often by the end of the following plan year.
When forfeitures linger too long, it becomes an operational failure.
2. Misalignment with the plan document
This is the most common one.
We often see sponsors using forfeitures to offset contributions… when the plan document only allows you to use them for expense payments (or vice versa).
Even if the way you’re using forfeitures is permitted under IRS rules, it’s not compliant if your specific 401(k) plan document does not permit it.
3. Contribution timing confusion
Forfeitures frequently intersect with employer contributions—especially matching or profit-sharing.
For example, if you use forfeitures to offset employer contributions, the funding source shifts—but the obligation doesn’t disappear. The plan still treats the contribution as made to participants; it’s just funded differently.
Miss this nuance, and you can run into issues with contribution calculations or testing.
4. Terminations and vesting missteps
Terminations trigger forfeitures—but when they happen matters.
Depending on your plan, forfeitures may occur:
- Upon distribution, or
- After a break-in-service period
Misapplying timing rules can lead to incorrect account balances—and audit flags.
A quick, practical self-check
If you’re not sure how you’re treating forfeitures in your 401(k) plan, here are the three questions to ask:
✅ Do your forfeitures align with your plan document?
✅ Are you using them within the required timeframe?
✅ How consistently are you applying them within your employer contribution strategy?
If any of those answers are “Umm… I think so,” it’s worth a closer look.
Because forfeitures may be small line items—but when plan sponsors handle them incorrectly, they can create very real compliance risk.
If your plan treats forfeitures in any of the ways we mentioned—set-it-and-forget-it, misalignment with the plan document, or timing confusion around contributions, terminations or vesting—you may be at risk of noncompliance, with real consequences at your next 401(k) plan audit.
Whatever you find, don’t panic! Document, document, document, and call your friendly neighborhood auditors with your questions. If you’re ready to partner with an auditing firm that cares about your organization, contact Cassell Plan Audits today.
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