Over the past year, numerous employers and their 401(k) plan fiduciaries have faced lawsuits regarding how forfeited employer contributions to their 401(k) plan are used. This wave of lawsuits began approximately a year ago when an employees’ law firm filed putative class action lawsuits raising this novel claim in California federal courts against multiple large employers, including Intuit, Clorox, and Thermo Fisher Scientific. Since then, this claim has been included in numerous 401(k) plan lawsuits even though none of these lawsuits has reached a final judgment on the merits, and only four have had decisions on motions to dismiss.
These lawsuits allege that the employer and its 401(k) plan fiduciaries breached their fiduciary duties under the Employee Retirement Income Security Act of 1974 (ERISA), as amended by using forfeited employer contributions to the 401(k) plan to offset future employer contributions instead of using the forfeited amounts to offset 401(k) plan expenses that were charged to participant accounts. The employees’ counsel alleges that the employer and 401(k) plan fiduciaries are violating ERISA’s fiduciary requirements to make decisions for the benefit of plan participants because the employer benefits from a reduction in its future employer contributions at the expense of plan participants who have to pay for certain expenses that are charged to their 401(k) accounts.
The claim is surprising and potentially problematic for employers because using forfeited employer contributions to offset future employer contributions is a longstanding common practice that has been approved by the Internal Revenue Service (IRS). From a business perspective, imposing a vesting schedule on employer contributions—such as matching contributions to a 401(k) plan—is a useful retention tool.
When employees terminate employment before becoming fully vested in their employer contributions, the forfeited amounts are allocated to the 401(k) plan’s forfeiture account. 401(k) plan documents typically provide flexibility for forfeited employer contributions to be used to either offset future employer contributions or to pay plan expenses. IRS guidance—including proposed regulations issued last year (88 FR 12282 (Feb. 27, 2023))—approve of this approach. Logically, employers typically opt to use the forfeited amounts to offset future employer contributions.
Surprisingly, to date, the four district court rulings on motions to dismiss have been mixed, so employers will want to be mindful that these lawsuits may continue for at least the near term. For example, the lawsuit against Intuit (Rodriguez v. Intuit Inc., No. 23-cv-05053, 2024 WL 3755367 (N.D. Cal. Aug. 12, 2024)) survived a motion to dismiss, while the lawsuits against HP (Hutchins v. HP Inc., No. 23-cv-05875, 2024 WL 3049456 (N.D. Cal. June 17, 2024)) and BAE Systems (Naylor v. BAE Systems, Inc., No. 1:24-cv-00536, 2024 US DIST LEXIS 160188 (E.D. Va. Sept. 5, 2024)) were dismissed. The 401(k) plan documents in these lawsuits each included a provision allowing the employer to use forfeited amounts to offset future employer contributions, which makes the denials of the employers’ motions to dismiss more surprising.
With 401(k) plan documents typically providing discretion to use forfeited amounts to offset future employer contributions and the IRS approving such an approach, it would appear the employers and their 401(k) plan fiduciaries did nothing wrong, and these lawsuits should be dismissed for failing to state a claim.
For employers whose 401(k) plan document contains the typical provision providing flexibility for forfeited employer contributions to be used to either offset future employer contributions or to pay plan expenses, one potential approach for an employer to minimize exposure to a similar lawsuit is to amend its 401(k) plan to require forfeitures to be applied to offset future employer contributions. Presumably such a hardwired 401(k) plan provision, which an employer may opt to include as a settlor (nonfiduciary) decision, negates the argument currently being made by employees’ counsel that plan fiduciaries are exercising their discretion to impermissibly favor the employer over 401(k) plan participants.
Alternatively, you could choose to use forfeitures to pay plan expenses—such as recordkeeping fees—or pay those fees directly. Such an approach would seemingly align what employees’ counsel claims should have been done in the lawsuits but at additional cost to the employer. With none of these lawsuits reaching a final judgment and only four of the lawsuits reaching decisions on motions to dismiss, employers and 401(k) plan fiduciaries whose 401(k) plan documents contain typical language regarding the use of forfeitures could also decide to let more of these lawsuits play out before making any changes.
Alex White is an attorney with Holland & Hart LLP in Denver, Colorado, and can be reached at adwhite@hollandhart.com.
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