Will the wave of ERISA lawsuits related to the handling of retirement plan forfeitures result in a potential upheaval of how these funds must be managed? Only time will tell, but as allegations continue to mount up and wind their way through the courts, risk management experts and defense attorneys provide guidance for plan sponsors.
Understanding the Forfeiture Allegations
Since 2023, a wave of ERISA lawsuits against retirement plan fiduciaries, such as sponsors, has been calling long accepted practices related to the handling of plan forfeitures into question. Typically, when an employer sponsors a retirement plan and commits to a match against the money an employee saves, a timeframe is set for when the employee becomes eligible for these funds (aka “fully vested.”) If an employee leaves the business before becoming eligible, the funds from the employer match are essentially forfeited. At 401k Specialist Magazine, national risk management expert, and Chief Insurance Officer for Colonial Surety Company, Richard Clarke, points out that ERISA regulations do not provide protocols for the use of plan forfeitures, and that it has become a generally accepted practice of employers to use forfeited funds to offset their costs. Experts at Plan Sponsor, concur, noting that use of forfeitures to “reduce future employer contributions or to pay reasonable expenses” is permitted in “almost all defined contribution plans.” Nonetheless, as Clarke explains, 401k forfeiture lawsuits are on the rise, “with plan sponsors accused of misusing forfeited funds instead of reinvesting them for participants.”
At the heart of the current legal challenges is the contention that utilizing forfeited funds to lessen employer contributions, rather than directly benefiting participants through reduced expenses, runs counter to the exceptionally high fiduciary standards enshrined in ERISA. So far, the forfeiture allegations have had mixed courtroom outcomes, as experts at Winston& Strawn explain:
While the litigation challenges long-standing IRS rules, the court outcomes have been mixed. In initial cases, several district courts declined to dismiss claims, resulting in closer scrutiny of the employer’s decisions. However, in recent cases such as Hutchins v. HP Inc., plan sponsors have successfully defeated similar claims, with the Hutchins court noting that these claims ignore “decades of settled law,” the plaintiff’s interpretation “is implausible in light of the long history of using forfeitures to reduce employer contributions,” and that these claims stretched “the fiduciary duties of loyalty and prudence beyond the law and create benefits beyond what was promised in the Plan itself.”
Although recent cases offer hope that forfeiture allegations will not spiral into copy cats impacting businesses of all sizes, defense attorneys are encouraging retirement plan sponsors to review plan documents and consider these actions to limit risk exposure related to the use of forfeitures:
The first step to mitigating risk is understanding whether the plan documents contain discretionary language permitting the use of forfeitures for plan expenses or future employer contributions. If so, consider:
- Narrowing the acceptable uses of the plan’s forfeiture account to one category of expenses (g., employer contributions only or plan expenses paid by the employer only), or
- Identifying one category of expenses to always be paid first.
If the employer determines that it is comfortable losing flexibility in utilizing funds as they see fit, non-discretionary language can be added through a plan amendment, so that there would no longer be a choice for the fiduciary to make, which decreases liability…..If a pre-approved plan includes non-tailorable discretionary language, the employer may be stuck or risk loss of protection of the pre-approved plan design. An alternative solution could be adopting a separate policy selecting non-discretionary uses of forfeitures that fit within the existing pre-approved plan terms.
Important To Do: Adhere To The Plan Document
Failure to follow a company sponsored retirement plan’s own governing documents can–and does–lead to investigations and litigation. These can impact companies and plans of every size, and drag on over years, significantly disrupting businesses and costing a fortune in defense, even before an outcome is reached. For example, a complaint against a Kentucky employer, brought by the Department of Labor back in 2017, was only recently resolved, with a courtroom agreement to pay “$575,000 to the plan participants who were harmed by defendants’ use of the forfeiture funds.” The investigation and litigation rested on the apparent discrepancy between the plan document and plan administration: though the plan document stipulated how forfeitures were to be used to pay plan expenses, they were instead applied to offset employer contributions.
Best Practice: Protection
It is important for plan sponsors to understand that as fiduciaries, we “can be held personally liable for damages, even decades into the future.” Even when plan services are outsourced, getting caught up in allegations turns out to be costly and time consuming. It’s best to be protected. Armed with Colonial’s liability coverage, if you face claims of alleged or actual breaches of duty in connection with the employee retirement plan, you’ll be protected with defense costs and penalty limits up to $1,000,000. At Colonial, a whole year of Fiduciary Liability coverage is less than a few dollars a day, and we even include Cyber Liability coverage to further protect you, your business and the retirement plan.
Protection–and peace of mind–are just a few clicks away:
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