What Is a Forfeiture Account in a 401(k) Plan?

A forfeiture account in a 401(k) plan is a holding account inside the plan where unvested employer contributions go when an employee leaves before earning full ownership of that money. Your own paycheck deferrals are always yours and never enter this account. The forfeiture account only collects the employer match or profit-sharing dollars the departing worker hadn’t yet vested in, and it holds that money temporarily until the plan puts it toward one of a few uses the IRS allows.

What Lands in the Account

Vesting is the schedule that decides when employer contributions actually belong to you. Your own salary deferrals are fully vested from day one, so they can never be forfeited no matter when you leave.¹ Employer contributions are different. Federal law permits two main schedules for them:

Cliff vesting. You own 0% of employer contributions until you complete a set number of years, then jump to 100%. The most restrictive cliff schedule allowed for matching contributions is three years.¹
Graded vesting. Ownership builds over time. The most restrictive graded schedule runs six years: 20% after year two, 40% after three, 60% after four, 80% after five, and 100% after six.¹

Say your plan uses the six-year graded schedule and you leave after four years. You keep 60% of the employer contributions. The other 40% moves into the plan’s forfeiture account.

When the Forfeiture Actually Happens

A forfeiture doesn’t always happen the moment someone walks out the door. The plan document picks one of two triggers:

The employee takes a distribution. Many plans forfeit the unvested portion as soon as the terminated employee takes a full distribution of their vested balance. This is the more common approach because it keeps the books clean.
Five consecutive breaks in service. If the plan doesn’t accelerate, it waits. Once the former employee completes five consecutive plan years without working at least 500 hours in any of them, the unvested balance is forfeited.¹

Either way, the nonvested dollars end up in the same place.

How the Money Can Be Used

The employer cannot pocket the money, and it cannot sit in the account indefinitely. The plan document has to specify which of three IRS-approved uses apply:

Offset future employer contributions. This is the most common use. If the employer owes $50,000 in matching contributions for the year and the forfeiture account holds $10,000, the employer only needs to contribute $40,000 in new cash.
Pay reasonable plan expenses. Recordkeeping fees, third-party administration costs, and required audit fees can be paid from forfeitures if the plan document authorizes it and the expenses are reasonable.
Reallocate to remaining participants. Some plans hand out forfeited amounts among current eligible participants as extra employer contributions. The allocation formula has to be nondiscriminatory so it doesn’t favor higher-paid employees.

What’s on the table depends on the plan document. A plan that only authorizes offsetting future contributions cannot suddenly redirect forfeitures to pay administrative expenses without an amendment first.

Getting Forfeited Money Back After Rehire

If you leave, take a distribution, and get rehired by the same employer within five years, you may recover forfeited money. Plans that use accelerated forfeitures can include a buy-back provision: repay the distribution you received, and the plan restores the previously forfeited employer contributions to your account.

There’s a wrinkle for employees who were 0% vested when they left. Because they had no vested balance to distribute, the plan treats them as having been cashed out with a zero-dollar distribution. If one of those employees returns within five years, the plan can automatically restore the forfeited balance without requiring any repayment.

Restoration money can come from current balances in the forfeiture account, or the employer may need to make additional contributions to cover it. That’s one reason plan sponsors can’t treat a forfeiture balance as free money. A wave of rehires can create restoration obligations that eat into or even exceed what’s sitting there.

The 12-Month Deadline

IRS proposed regulations require that forfeitures be used no later than 12 months after the close of the plan year in which they occurred.² A forfeiture that arises during the 2025 plan year, for example, needs to be applied by the end of 2026. Letting forfeitures accumulate past that window is an operational compliance failure that can put the plan’s tax-qualified status at risk.

The proposed regulations also include a transition rule for older, unapplied balances. Forfeitures incurred in any plan year beginning before January 1, 2024, are treated as if they occurred in the first plan year beginning on or after that date.² For a calendar-year plan, that means legacy forfeitures needed to be cleared by the end of the 2025 plan year.

When a Layoff Wipes Out the Forfeiture Entirely

Large layoffs can override a plan’s vesting schedule. If a plan undergoes a partial termination, every affected employee becomes 100% vested in their account balance as of that date, so there is nothing to forfeit.¹

The IRS uses a facts-and-circumstances test to decide whether a partial termination has occurred, but a turnover rate of 20% or more during the applicable period creates a strong presumption that one did.³ An employer can push back by showing that the departures were genuinely voluntary or that the turnover rate matched historical norms. Personnel files, employee statements, and proof that departed workers were replaced with people doing the same jobs all count as evidence.

Fixing Forfeiture Mistakes

Forfeiture errors show up in a few predictable ways: failing to forfeit nonvested amounts on time, using forfeitures for purposes the plan document doesn’t authorize, or letting balances pile up year after year without being applied.

The IRS offers two paths for correcting these operational failures through its Employee Plans Compliance Resolution System. Self-correction lets plan sponsors fix many errors without filing an application or paying a fee, and it works best for problems caught early that don’t involve large dollar amounts.⁴ For bigger problems, or ones that don’t qualify for self-correction, the Voluntary Correction Program requires a formal application and a user fee.⁵ Either route costs far less than what happens if the IRS discovers the problem during an audit, when penalties escalate and the plan’s qualified status can be on the line.

1
Office of the Law Revision Counsel. 26 USC 411 – Minimum Vesting Standards
2
Federal Register. Use of Forfeitures in Qualified Retirement Plans
3
Internal Revenue Service. Partial Termination of Plan
4
Internal Revenue Service. Self-Correction of Retirement Plan Errors
5
Internal Revenue Service. Voluntary Correction Program (VCP) Fees