Retirement Plan Sponsors Must Protect Against Forfeiture Suits

A spate of lawsuits has raised questions about how 401(k) plans may use plan forfeitures. Plaintiffs in these suits allege that plans should use forfeiture funds to pay plan fees, which would otherwise be paid by participants, rather than using them to pay employer contributions, which would otherwise be paid by the employer.

Though no employer or plan committee has been found liable for using forfeiture funds toward employer contributions, these lawsuits already involve real costs. Surviving a motion to dismiss, as some plaintiffs have, means that defendants become subject to discovery. Some defendants may prefer to settle than to incur these costs and the uncertainty of litigation.

Sponsors of 401(k)s and other defined contribution plans should monitor recent 401(k) forfeiture litigation and work with counsel to protect themselves as effectively as possible.

Review Forfeiture Usage

Plan sponsors concerned about facing a 401(k) forfeiture lawsuit should first review how they use their 401(k) forfeitures. Some plan sponsors use forfeitures to pay plan expenses, with either the plan sponsor or plan participants paying the remaining expenses. These sponsors wouldn’t be targeted in the current wave of lawsuits.

Clarify That Usage Follows Plan Sponsor Direction

For plan sponsors who use forfeitures to pay employer contributions, perhaps the most effective measure they can take is to codify this arrangement. They could do this by amending their 401(k) plan document to state that forfeitures must be used to pay employer contributions.

Such an amendment might state that forfeitures can only be used to pay employer contributions, in which case the plan sponsor would have to amend the plan to permit other uses if it later froze. The amendment may alternatively state that forfeitures must initially be used to offset employer contributions, but that any excess can be used to pay plan expenses.

Either way, this type of plan amendment aims to establish that the plan committee isn’t exercising discretion or making a fiduciary decision when using forfeitures to pay employer contributions. Instead, the “decision” would be baked into the plan document, which the committee would follow under its duty to comply with the plan document.

The way a 401(k) plan is designed can affect how it is amended. Individually designed 401(k) plans can draft and adopt amendments at will.

But a plan sponsor that has elected to use a pre-approved document—such as a prototype or volume submitter plan—would need to work with the document provider to modify its plan. Such sponsors may be offered optional amendments from their document providers or might adopt an addendum to their pre-approved plan in coordination with their document providers.

If neither of these options is available, a plan sponsor might consider a corporate resolution directing that plan forfeitures be used to pay employer contributions.

Other Possibly Protective Strategies

Sponsors that seek to further mitigate the risk of lawsuits may consider several other measures. These ideas are mentioned or inspired by the case law but are more novel or less comprehensive than having the plan sponsor direct forfeiture use, so they shouldn’t replace that option if it is available.

Amend key plan definitions. Plan sponsors may wish to amend their plan documents to dictate that forfeitures aren’t considered “plan assets” or “plan property,” and that nonvested contributions are considered “contributions made by mistake.”

Though it isn’t clear how these positions might be sustained under the Employee Retirement Income Security Act, courts deciding on forfeiture lawsuits have emphasized that these positions have yet to be ruled on as a legal matter, and that plans taking these positions might be protected from some ERISA claims related to forfeiture use, such as anti-inurement or prohibited transactions.

Document grounds for forfeiture use. One court that declined to dismiss an ERISA prudence claim specifically mentioned the plan committee’s lack of deliberation about forfeiture use.

Plan committees taking the position that forfeiture usage isn’t subject to fiduciary discretion may not deem it necessary or consistent to document their deliberative process. But perhaps an effective balance can be struck: Before forfeiture funds are applied to employer contributions, plan committees may wish to execute concurrent documentation clarifying that the plan sponsor is directing (and, if relevant, implementing) the forfeiture use.

Adjust employer contribution formulas. Plan sponsors might amend their plans to state that employer contributions are reduced by the amount of administrative expenses paid on participants’ behalf via forfeiture funds.

This structure effectively builds in the option that a plan sponsor already retains to reduce benefits on a going-forward basis. If courts insist that plans can’t use forfeiture funds to fund contributions, sponsors can simply reduce contributions.

Hardwiring this possibility may help plan sponsors demonstrate more clearly why plaintiffs aren’t harmed when forfeiture funds pay employer contributions. This strategy would work with a discretionary match or profit-sharing contribution. But it wouldn’t work with a plan that has nondiscretionary or safe harbor employer contributions because employers can’t generally reduce those contributions within the plan year.

Allow participants to autopay plan fees from payroll. If plan fees aren’t paid from participants’ retirement accounts, plaintiffs may have a harder time convincing a court that they sustain damages in their capacity as plan participants under ERISA when forfeitures aren’t used to pay those fees.

This approach may have benefits beyond protecting plan sponsors from forfeiture litigation. It would ensure that more of the money participants contribute to the plan is being invested for retirement rather than paying plan fees. It may also provide some protection against other ERISA claims related to plan fees. But this design may attract increased attention to plan fees and introduce administrative complexities, so plan sponsors should carefully weigh its pros and cons.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jodi Epstein is partner at Ivins, Phillips & Barker with more than 25 years of experience with all aspects of employee benefits.

Alex Maged is an associate at Ivins, Phillips & Barker and supports clients on a wide range of employee benefits issues.

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