With large-scale layoffs making headlines and more than 30 pending ERISA class action lawsuits targeting the misuse of forfeited 401(k) funds, plan sponsors need to be vigilant about their fiduciary responsibilities. A recent Employee Benefit News article highlights the growing risks and outlines preventative measures employers should consider.
When employees leave before being fully vested in their retirement plans, their unvested employer contributions are forfeited. According to the Department of Treasury, these forfeited funds can be used in three ways:
- To pay administrative expenses (though this approach risks excessive fee litigation)
- To reduce employer contributions under the plan
- To increase benefits and other participants’ accounts in accordance with plan terms
Despite these clearly defined options, the legal landscape remains treacherous, with dozens of lawsuits alleging ERISA violations related to forfeiture practices.
Plan sponsors facing layoffs should be aware of the “partial termination” rule. If a reduction in force impacts 20% or more of plan participants within a year, it may classify as a partial plan termination. In such cases, all affected employees must be automatically vested and entitled to receive their full 401(k) benefits.
Richard Clarke, chief insurance officer at Colonial Surety Company, which specializes in business liability insurance, was quoted in the article. He recommended several proactive approaches for plan sponsors:
- Consider fiduciary liability insurance to protect against claims of mismanagement and associated legal liability.
- Enhance employee education through consistent communication about retirement plans. Many employees don’t fully understand terms like “forfeiture” and “vesting,” and often assume all funds in their accounts belong to them. Mr. Clarke recommended clearly explaining what employees are and are not entitled to should layoffs or other circumstances cause them to leave their employer. This proactive approach helps employees better plan for their financial futures while preventing confusion that could lead to disputes later.
- Clarify third-party responsibilities by ensuring contracts with outsourced benefits administrators clearly specify their role (if any) in employee communications throughout the year.
- Simplify communications by creating digestible materials—whether print or electronic—that highlight key provisions such as employer matching percentages and vesting periods.
Even if layoffs aren’t on the horizon, these protective measures should serve as best practices for all plan sponsors. As Mr. Clarke noted, “We hope that all employers want as many employees as possible to participate in an employer match. The employer can say, ‘Here’s what we’re trying to do to help you with your financial security long-term.'”
By implementing these strategies, plan sponsors can minimize their fiduciary risk while maximizing the effectiveness of their retirement benefits as both a recruiting and retention tool.
