401(k) plan forfeitures occur when a participant terminates employment (voluntarily or involuntarily) prior to satisfying the required service years to become fully vested in his/her account. Required service years will vary by plan, but can be found in your summary plan description. The portion of your account subject to forfeitures is the portion that is contributed by the employer, typically, through an employer matching contribution or an employer discretionary profit sharing contribution. Participants are generally always 100% vested in the contributions made by the participant.
Plan administrators can typically utilize forfeitures to pay plan expenses, to reduce employer matching contributions or employer discretionary profit sharing contributions, or to allocate to existing participants on a pro-rata basis. (Specific uses are governed by the plan document.)
The following example assumes an employee has satisfied three service years and the employer has contributed $1,000 to the employee’s account. Additionally, the plan has the following vesting schedule documented in its plan document.
|Service years||Vesting % earned|
Given the detail above, the individual is 60% vested in the employer contributions and will receive $600 of the $1,000 in the account. The formula for the forfeited portion is: forfeited portion = total employer contribution balance x (1 – % vested).
As a participant, it is important to know your 401(k) plan’s forfeiture and vesting policy (found in your plan document or summary plan description) to ensure the following:
- The proper amount of termination benefit is paid to you, upon termination.
- If you have received an underpayment of termination benefits, the plan may be responsible to compensate you for the underpayment and any lost earnings potential on that underpayment.
- If you have received an overpayment of termination benefits, you may be obligated to reimburse the plan by the overpayment amount.
- The plan administration is properly utilizing forfeitures received, (i.e. if forfeitures are to be remitted to existing participants, then you will want to ensure you receive your correct portion).
Some issues that typically result in forfeiture calculation errors are:
- The participant has a “break in service” (an extended absence from employment),
- The plan document is amended and also amends the vesting schedule,
- Partial plan termination is incurred, and
- Inaccurate records of employer contributed balances versus participant contributed balances
The previous issues should be carefully considered when verifying if your forfeitures were calculated correctly.