DOL guidance: 401(k) forfeiture use allowed under ERISA

Retirement plan sponsors facing a wave of litigation over their use of forfeited 401(k) funds just received a powerful ally: the Department of Labor.

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In a Jan. 8 court filing, the Labor Department urged the 9th Circuit Court of Appeals to uphold the dismissal of Wright v. J.P. Morgan Chase. The class action alleged that J.P. Morgan violated the Employee Retirement Income Security Act (ERISA) and its fiduciary duties by using forfeited plan assets to offset its employer contribution obligations rather than benefit its plan participants

In its brief, the Labor Department explicitly sided with J.P. Morgan, arguing that using forfeited funds to offset employer contributions is a standard practice that does not violate ERISA.

This is the DOL’s latest filing in a series of lawsuits testing the novel legal theory around ERISA standards. The agency first broke its silence on the issue last July, when it filed a similar amicus brief in Hutchins v. HP. Then, last month, the Labor Department requested additional time to file an amicus brief in another forfeiture reallocation case involving Honeywell International.

A novel legal theory challenges ERISA requirements

The government’s involvement comes at a critical moment. Over the past year, a wave of ERISA class action lawsuits has targeted how plan sponsors handle “forfeitures,” the leftover assets in a 401(k) account when an employee leaves a job before they are fully vested in the company’s matching contributions.

While employee contributions are always vested immediately, employer matches often vest over time. When an employee exits early, that unvested money returns to the plan. Many employers use these forfeited funds to offset their future contribution obligations, a practice the DOL’s briefs defend as a “settlor” decision regarding plan funding and design, rather than a fiduciary management decision.

However, the recent surge of lawsuits argues that those dollars are plan assets that should instead be used to cover administrative expenses, thereby lowering fees for the remaining participants.

The DOL rejected this framing in its latest brief, criticizing the plaintiffs for making “bare allegations” of imprudence without factual proof. The agency noted that as long as the plan document allows for such use, a fiduciary does not violate their duty of loyalty simply by reducing the employer’s financial burden.

A rising tide of litigation

The forfeiture cases are part of a broader trend of aggressive ERISA litigation. 2024 marked the third consecutive year in which the top 10 ERISA class action settlements totaled $400 million or more, according to a report from law firm Duane Morris.

Gerald Maatman Jr., co-author of the report and chair of the firm’s class action defense team, told Financial Planning last year that the rise in litigation was fueled by a “migration of very skilled plaintiff’s lawyers into the space” who are testing “novel theories” to challenge established norms.

In most of these cases, disputes over how to allocate forfeitures arise because plan documents often give employers discretion over how those funds are used. Under ERISA, discretionary decisions are fiduciary in nature and therefore subject to duties of loyalty and care, according to Carl Engstrom, a partner at Minneapolis, Minnesota-based law firm Engstrom Lee.

Engstrom, who has represented employees in retirement plan malfeasance cases, said that the most likely outcome of the litigation is that employers will remove that discretion from plan documents and instead specify that forfeitures be used to offset employer contributions to the plan. In effect, the lawsuits could work to formalize the current practice rather than change it.

Where ERISA class actions go next

With the Labor Department now weighing in against these claims for the second time, the landscape may be shifting. Maatman said that the DOL’s stance marks a notable, if unsurprising, pivot for the agency.

“Pivots in legal positions by the government — based on the White House changing from blue to red (or vice-versa) — is nothing new,” Maatman said. “The latest involving the DOL’s ‘new’ position under ERISA on the legality of use of forfeited 401(k) funds by fiduciaries to offset their own costs is yet another example.”

Still, even with the Labor Department’s backing, plan sponsors shouldn’t assume they’re safe from similar ERISA class action lawsuits moving forward, Maatman said.

“It remains to be seen if this pivot dampens the pursuit of such ERISA class actions by the private plaintiffs’ bar,” he said. “Most likely it will not, as the plaintiffs’ class action bar often ‘fills the void’ when governmental enforcement litigators pull back from an area of risk.”

Engstrom said that such forfeiture cases will be “severely limited” moving forward, citing briefs from the Labor Department and a broader trend in judicial opinions. But, he added, these cases may continue in instances where a sponsor’s plan document explicitly requires them to use the forfeited funds in a way that they did not follow.

“I don’t think these holdings will bar a case where, for example, the plan document says that forfeited funds are to be used to pay plan expenses, and then, if no expenses are left to be paid, can be used to reduce employer contributions, as an example,” he said. “But this is a small subset of the lawsuits that have been brought, so I do think the forfeiture cases have been severely curtailed.”