Ninth Circuit Weighs Employer’s Use of Non‑Vested 401(k) Funds

[co-authors: Rajveer Walia¹ and Ethan Scott²]

What can employers do with non-vested employer contributions? Under the Employee Retirement Income Security Act of 1974 (“ERISA”), employers may require an employee to work for a set number of years before any company contributions to an employee’s 401(k) account “vest” and become owned by the employee. If an employee decides to leave the employer before the vesting period is complete, the employee “forfeits” any non-vested employer 401(k) contributions. For decades, when these forfeitures occurred, employers would use the forfeited assets to help offset future employer contributions to the 401(k) plan. Now, various plaintiffs have started challenging this practice, claiming that employers violate various provisions of ERISA by using forfeited assets to offset employer contributions when instead the employer could use those assets to offset plan participant expenses. District courts have ruled on a number of these cases, often agreeing that employers may use these forfeited assets to reduce their future contributions into the 401(k) plan. For the first time, the issue has been appealed and is currently pending before the Ninth Circuit.

In Hutchins v. HP Inc., et al., the district court dismissed a 401(k) plan participant’s claim that his employer breached its fiduciary duties under ERISA. In Hutchins, theemployer used 401(k) plan (the “Plan”) forfeitures to reduce future employer contributions rather than to pay the Plan’s administrative costs—costs for which the employees share the expense. The ultimate question is whether the employer’s allocation of these forfeited funds violated ERISA.

Under the Plan, participants who left the employer before three years of service forfeited the employer contributions to their respective 401(k) accounts. The Plan language provided the employer with complete discretion in utilizing the forfeited funds, including authorizing the employer to reduce its future contributions or pay Plan expenses. Plaintiff alleges that between 2019 and 2023, the employer chose to use forfeitures to offset its own contributions into the Plan and charged administrative Plan expenses to the participants’ accounts.

The complaint asserted that the employer: (i) breached its duty of loyalty by imposing Plan expenses on participants’ accounts, contrary to participants’ interests; (ii) breached its duty of prudence by failing to investigate how to best allocate the forfeitures; and (iii) engaged in self‑dealing by utilizing forfeiture contributions chiefly for its own interests. In its motion to dismiss, the employerargued that its forfeiture allocation was permissible, common across employers, and consistent with the Plan’s terms. The district court agreed that using forfeitures to reduce employer contributions is an acceptable, well-established practice. Further, even by using the forfeited funds to reduce the employer’s future liability, all Plan participants, including the plaintiff, received the benefits they were entitled to under the Plan.

According to the district court, the plaintiff’s claims failed to demonstrate any plausible inference of the employer’s wrongdoing. The court agreed that the plaintiff showcased a conflict of interest: the employer’s cost-saving interests in offsetting employer contributions versus the Plan participants’ interests in avoiding administrative Plan expenses. However, this alone was insufficient to find that the employer breached its duties under ERISA or the Plan’s terms because: (1) plaintiff’s argument that the employer is required to use forfeited funds to reduce Plan expenses is not supported by the law, thus providing no basis for breach of loyalty or prudence claims; and (2) the employer’s decision to use forfeitures to offset employer contributions involved no “transaction” as required under 29 U.S.C. § 1106’s prohibition against “self-dealing” and provided no basis for such a claim. Thus, the court dismissed all of plaintiff’s claims with prejudice.

Plaintiff appealed to the Ninth Circuit arguing that the lower court applied the wrong legal standard by focusing on whether employers are always required to pay Plan expenses over future employer contributions, rather than specifically focusing on the facts at hand. Plaintiff also reemphasized ERISA’s requirement that fiduciaries act “solely in the interest of the [plan] participants.” See 29 U.S.C. § 1104(a)(1). The plaintiff suggests that this provision requires employers to thoroughly investigate and select the forfeiture allocation option most favorable to participants.

The employer raised the same defenses it argued in district court, and the Department of Labor (“DOL”) filed an amicus curiae brief in favor of the employer. The DOL argued that utilizing forfeitures to offset employer contributions alone does not violate ERISA. Additionally, the DOL argued that ERISA’s requirements for fiduciaries to consider plan funding, design, and risks of litigation often support the practice of employers utilizing forfeitures to offset employer contributions because this practice better ensures that participants will timely receive their employer contributions. Lastly, the DOL emphasized that the employer’s practice aligned with U.S. Treasury regulations.

This case is currently before the Ninth Circuit on appeal. Plan sponsors and administrators should closely monitor the Hutchins appeal because the decision should clarify the extent of discretion plan administrators may wield regarding the use of forfeited funds, and the decision may shape new practices for retirement plan design and administration. If the district court decision is upheld, plan sponsors may continue to offer administrators discretion in how to allocate forfeited funds (consistent with plan terms). If, however, the district court is reversed, plan sponsors and administrators will need to consider what discretionary authority their 401(k) plans provide and potentially consider amending plan documents to specifically authorize using forfeitures to offset employer contributions.

Footnotes

1. Rajveer Walia was a summer associate in Snell & Wilmer’s Phoenix office, working under the supervision of Zachary Schroeder. He is anticipated to graduate from Cornell Law School in May 2027. He is not admitted to practice law.

2. Ethan Scott was a summer associate in Snell & Wilmer’s Phoenix office, working under the supervision of Anne Meyer. He is anticipated to graduate from University of Arizona, James E. Rogers College of Law in May 2027. He is not admitted to practice law.