An employer sponsoring a 401(k) plan can use money in the forfeiture account in three ways: paying reasonable plan administrative expenses, offsetting future employer contributions, or reallocating the funds to remaining participants’ accounts. A fourth use comes up in a specific situation, which is restoring a previously forfeited balance when a former employee is rehired. The plan document has to specify which method the sponsor uses, and the money cannot leave the plan for the company’s general business purposes. Both the Internal Revenue Code and ERISA prohibit it: plan assets must be held exclusively for participants and beneficiaries and for defraying reasonable plan expenses.1Office of the Law Revision Counsel. 26 USC 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans2Office of the Law Revision Counsel. 29 USC 1103 – Establishment of Trust A company facing a cash crunch cannot raid the forfeiture account to cover payroll or pay off debt.
Paying Reasonable Plan Expenses
Using forfeitures to pay plan expenses keeps those costs from being drawn out of participant balances. Eligible costs include recordkeeping fees, legal work tied to plan compliance, trustee services, and annual audit fees.3U.S. Department of Labor, Employee Benefits Security Administration. A Look at 401(k) Plan Fees The statute requires these fees to be “reasonable” rather than setting a fixed cap, so what qualifies depends on the plan’s size and complexity.
There’s a line here that trips up sponsors. The Department of Labor separates administrative expenses (running the plan day to day) from settlor expenses (decisions about creating, designing, or changing the plan). Forfeitures cannot pay for settlor functions.4U.S. Department of Labor. Guidance on Settlor v. Plan Expenses That rules out plan design studies, benefit analyses used in union negotiations, actuarial projections prepared for the company’s financial statements, and legal fees to amend the plan to add new features such as a loan program. The test is whether you are administering the plan as it exists or making business decisions about what the plan should look like. The first can come out of forfeitures. The second is the employer’s cost.
Offsetting Employer Contributions
Forfeitures can reduce the cash an employer needs to fund matching or non-elective contributions. If the company owes $50,000 in matching contributions for a quarter and has $8,000 in the forfeiture account, only $42,000 in new money needs to move into the plan. Participants receive the same contribution amount either way; the source is different, the result is not.5Federal Register. Use of Forfeitures in Qualified Retirement Plans
Safe Harbor Contributions
The IRS reversed an earlier position and now allows safe harbor 401(k) plans to use forfeitures to fund the required safe harbor employer contribution. Safe harbor contributions are mandatory: the employer commits to a specified matching formula or a 3% non-elective contribution in exchange for exemption from nondiscrimination testing. Applying forfeitures against that obligation gives real flexibility in years when the forfeiture account has built up a meaningful balance.
QNECs and QMACs
Plans that struggle to pass nondiscrimination testing can use forfeitures to fund Qualified Nonelective Contributions or Qualified Matching Contributions. These supplemental employer contributions help balance deferral rates between highly compensated and non-highly compensated employees. Under IRS regulations finalized in 2018, forfeiture money can fund QNECs and QMACs as long as the amounts become fully vested when allocated to participants.6Internal Revenue Service. Issue Snapshot – Plan Forfeitures Used for Qualified Nonelective and Qualified Matching Contributions Before that change, the prior rules required those contributions to be nonforfeitable at the time of contribution, which knocked forfeiture funding out.
Reallocating to Participants
Rather than reducing the employer’s out-of-pocket cost, a plan can push forfeited money directly into the accounts of eligible participants. The plan document sets both the allocation method and any eligibility conditions. A pro-rata method distributes forfeitures in proportion to each participant’s existing balance or compensation. A per-capita method gives every eligible participant an equal share.
These allocations count as annual additions under Internal Revenue Code Section 415, which caps total additions to a participant’s account at the lesser of $72,000 or 100% of compensation for 2026.7Office of the Law Revision Counsel. 26 USC 415 – Limitations on Benefits and Contribution Under Qualified Plans8Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs The cap covers everything combined: employee deferrals, employer match, profit-sharing, and forfeiture allocations. A sponsor reallocating a large forfeiture balance needs to check that no individual participant breaches the limit. This tends to surface in smaller plans where a handful of highly compensated employees are already close to the ceiling.
Restoring a Rehired Employee’s Account
When a former employee returns before incurring five consecutive one-year breaks in service, the plan may be required to restore the previously forfeited balance. The specifics depend on the plan’s terms and whether the employee took a distribution when they left. If they were cashed out, the plan document typically includes a buy-back provision under which the rehired employee repays the distribution amount and the plan restores the forfeited employer contributions.9Office of the Law Revision Counsel. 26 USC 411 – Minimum Vesting Standards
The forfeiture account is the first source used for these restorations.5Federal Register. Use of Forfeitures in Qualified Retirement Plans If it doesn’t hold enough, the employer has to contribute additional money to make the returning employee whole. This is not optional; it is a condition of maintaining a qualified plan.10Internal Revenue Service. Improper Forfeiture by Defined Benefit Plans
What Employers Cannot Do
The forfeiture account is not a slush fund. ERISA’s anti-inurement rule states that plan assets shall never inure to the benefit of any employer and must be held exclusively for providing benefits to participants and defraying reasonable expenses.2Office of the Law Revision Counsel. 29 USC 1103 – Establishment of Trust The tax code carries a matching exclusive-benefit rule.1Office of the Law Revision Counsel. 26 USC 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans Forfeitures cannot be returned to the employer as cash, applied against company debt, or used for anything outside the plan.
Employee salary deferrals never enter the picture. Those are always 100% vested and can never be forfeited. Only unvested employer contributions (matching funds, profit-sharing, and non-elective contributions that haven’t fully vested) end up in the forfeiture account.
The 12-Month Deadline
The IRS does not allow forfeiture accounts to sit indefinitely. Under proposed regulations (REG-122286-18), forfeitures must be used no later than 12 months after the close of the plan year in which they were incurred.5Federal Register. Use of Forfeitures in Qualified Retirement Plans For a calendar-year plan, forfeitures incurred during 2025 must be applied by December 31, 2026, whether that means paying expenses, offsetting contributions, or allocating to participants. Sponsors should confirm whether the proposed rules have been finalized and check for changes from the proposed version.11Reginfo.gov. View Rule – Use of Forfeitures in Qualified Retirement Plans
A transition rule handled older balances: forfeitures incurred in plan years beginning before January 1, 2024, were treated as incurred in the 2024 plan year. For calendar-year plans, those needed to be used by December 31, 2025. A pre-2024 forfeiture still sitting in the account in 2026 is an operational compliance problem that needs correction. Individually designed plans also face a separate deadline of December 31, 2026, to adopt conforming plan amendments.
Litigation Over the Offset Choice
A wave of lawsuits that began in the mid-2020s challenged the common practice of using forfeitures to offset employer contributions instead of reallocating them to participants. Plaintiffs argue that employers breach their fiduciary duty by choosing the option that saves the company money, and that offsetting contributions effectively lets plan assets benefit the employer in violation of the anti-inurement rule.
Most federal district courts have dismissed these claims early. Courts have generally found that ERISA does not require employers to maximize benefits for participants or resolve plan-document ambiguities in the workers’ favor. Because the money stays inside the plan trust when applied against a contribution obligation, courts have not found an anti-inurement violation, and they have rejected the theory that the practice is a prohibited self-dealing transaction.
No federal appeals court has ruled on these theories yet. As of early 2026, appeals are pending in the Third, Eighth, and Ninth Circuits, with the Ninth Circuit expected to rule first. Until then, the safest course for a sponsor is to follow whatever method the plan document specifies and to make sure the document reflects a deliberate choice among the permissible options rather than a default nobody revisited.