Every year, a few of your employees quit before their employer match fully vests. Their unvested dollars don't vanish. They slide into a holding pen inside your retirement plan called the forfeiture account — and then, at a surprising number of small businesses, they sit there. Year after year. Quietly growing into exactly the kind of stale balance that draws questions from auditors.
Retirement-plan auditors report finding plans with hundreds of thousands of dollars in forfeitures that were never used. The correction is painful: reconstructing, years later, which participants should have received the money and in what amounts. The good news is that the fix going forward is mostly calendar discipline. This guide explains where forfeitures come from, the three things you're allowed to do with them, the deadline for doing it, and the simple annual routine that keeps your plan clean.
Where Forfeitures Come From
Your employees' own salary deferrals are always 100% theirs. But the money you put in — matching contributions, profit-sharing, nonelective contributions — can be subject to a vesting schedule. Vesting is just a retention timer: leave early, and the unvested slice stays behind.
Federal law caps how long you can make people wait. For most 401(k) employer contributions, the schedule must be at least as generous as one of two statutory minimums:
- A 3-year cliff. Zero percent vested until three years of service, then 100%.
- A 6-year graded schedule. 20% after two years of service, adding 20 points a year until reaching 100% after six years.
(Some contribution types vest faster by law — safe-harbor matches, for example, generally must be immediately vested — but the classic match and profit-sharing dollars usually follow one of the two schedules above.)
When a participant leaves before fully vesting, the unvested portion is eventually forfeited under the plan's terms — typically when the former employee takes a distribution of their vested balance, or after five consecutive one-year breaks in service if they leave the money in the plan. Those dollars land in the plan's forfeiture (or suspense) account, waiting to be put to one of their permitted uses.
Put numbers on it and the stakes get concrete. Take a 30-person company with 10% annual turnover and an average unvested match of $3,000 per departing employee. That's roughly $9,000 a year flowing into the forfeiture account. Ignore the account for five years and you're sitting on $45,000 of other people's former retirement money with no plan for it — earning nothing for participants, helping no one, and visible on every recordkeeper statement an auditor will ever read.
The Three Things You're Allowed to Do With Forfeitures
Your plan document must spell out how forfeitures get used, and the IRS recognizes three permitted destinations:
- Pay reasonable plan administration expenses. Recordkeeping fees, audit fees, legal bills for plan matters — forfeitures can cover the costs you'd otherwise pay out of company cash or charge to participant accounts.
- Reduce future employer contributions. Apply the forfeiture balance against your next matching or profit-sharing deposit, so the company writes a smaller check.
- Reallocate to the remaining participants. Add the dollars to other employees' accounts, typically pro rata by compensation, as an extra employer contribution.
A 2018 rule change widened the toolbox further: forfeitures can now also fund corrective contributions such as qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and safe-harbor contributions — uses the IRS had previously blocked on a technical vesting-timing distinction. That matters because it gives you a productive home for forfeitures even in years when you aren't making a regular match.
One choice deserves a deliberate, documented decision rather than a default. In recent years, participants have sued plan sponsors alleging that using forfeitures to reduce the company's own contributions — instead of paying expenses that would otherwise be charged to participants — breaches fiduciary duty. The theory is contested and outcomes vary, but the lesson for a small employer is practical, not legal: read your plan document, understand which use it directs, decide with your adviser which permitted use serves participants best, and write down why. A contemporaneous note beats a reconstructed memory every time.
The Deadline: 12 Months After the Plan Year Closes
For years, the timing rule lived in informal guidance. A 2010 IRS newsletter said forfeitures should be used in the plan year they arose, with nothing left unallocated past year-end — and Treasury regulations have long said forfeitures must be used "as soon as possible to reduce employer contributions." Auditors enforced the spirit, but the letter was fuzzy.
The IRS moved to sharpen it. In proposed regulations issued February 27, 2023, the agency would require defined-contribution plans to use forfeitures no later than 12 months after the close of the plan year in which they were incurred, with the plan document itself stating the deadline. The proposed effective date is plan years beginning on or after January 1, 2024, with a transition rule treating any forfeitures arising in earlier years as though they arose in that first covered year — sweeping the whole stale backlog onto the same 12-month clock.
Proposal or not, the direction of travel is unmistakable, and both IRS and Department of Labor auditors already treat multi-year suspense balances as a finding. The safe operating rule is simple: zero the forfeiture account within the plan year the forfeitures arise, and never let a balance survive more than 12 months past year-end. Anything older than that is a correction project waiting to happen — and corrections mean hiring someone to figure out who should have gotten what, plus earnings, often across multiple prior years.
Why Stale Suspense Balances Draw Fire
Three separate risks converge on an untouched forfeiture account:
- Qualification risk. Forfeitures that pile up unallocated look like an employer holding plan assets in reserve rather than administering the plan per its terms. In the extreme, the IRS views chronic non-use as an operational failure that can threaten the plan's tax-qualified status — the status that makes everyone's contributions deductible and earnings tax-deferred.
- Correction cost. Fixing a multi-year backlog is one of the most labor-intensive corrections in the retirement-plan world. Under the IRS correction program, you generally must reconstruct the allocations participants would have received in each year the forfeitures sat idle, adjusted for earnings. Records get thin, staff turns over, and the billable hours stack up fast.
- Fiduciary and audit attention. Forfeiture handling now sits on standard auditor and DOL checklists, and as noted above, the choice between reducing employer contributions and paying participant-borne expenses has become active litigation territory. An account nobody monitors is the worst possible fact pattern for all three audiences.
None of this requires a big plan or a dramatic failure. The typical offender is an ordinary small business whose recordkeeper dutifully reports a forfeiture balance every quarter while nobody at the company owns the job of spending it down.
The Annual Forfeiture Routine That Keeps You Clean
Build this into your year-end close and forfeitures become a five-minute task instead of a five-figure correction:
- Name an owner. One person — you, your office manager, your TPA — is responsible for the forfeiture account. Put the quarterly review on their calendar, not in anyone's memory.
- Read your plan document. Confirm what it says about when forfeitures occur and how they must be used. If the document is silent or vague about timing, ask your TPA or benefits counsel to amend it toward the 12-month standard before an auditor asks first.
- Sweep the account every year. Before year-end, direct the recordkeeper in writing: apply the balance to the upcoming match deposit, pay the pending admin invoices, or allocate it to participants. Keep the instruction and the confirmation with your plan records.
- Reconcile like any other account. Your recordkeeper statement shows a forfeiture balance; your books should reflect the same reality. When you apply forfeitures against a match deposit, record the gross employer contribution expense in full and the forfeiture application separately — don't just book the net check. Clean gross-versus-applied tracking is what lets you answer an auditor's first question ("show me what happened to the 2025 forfeitures") without a scramble.
- Watch the audit tripwires. A forfeiture balance that grows three years running, a plan document that doesn't mention forfeitures at all, or suspense dollars older than the current plan year are all signals to act now, while the fix is still a memo rather than a formal correction filing.
If you've already got a backlog, don't just quietly spend it down and hope. Talk to your TPA about a proper correction — identifying the rightful recipients for each stale year — because misapplied "catch-up" allocations can create a second failure on top of the first.
Simplify Your Financial Management
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