Don't let layoffs put you at risk for a fiduciary breach

As large-scale layoffs and ERISA lawsuits alleging misuse of forfeited 401(k) money continue to make headlines, plan sponsors are on alert. 

Employee termination spiked in March, largely within the federal government, with more than 275,000 jobs cut, according to outplacement firm Challenger, Gray & Christmas. As tariffs and other economic obstacles mount for employers, they too may end up needing to reduce their workforce, and that is not the time they want to figure out the rules surrounding 401(k) forfeitures, let alone explain them to workers. 

A risk mitigation strategy of ensuring compliance, investing in insurance and educating employees about their retirement plans can help avoid mismanagement of 401(k) plans and the confusion that results in fiduciary breaches and legal trouble.

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Where employers are running into trouble

Currently, there are more than 30 pending ERISA class action lawsuits against employers, which allege that the practice of using forfeited 401(k) funds — the amount contributed by the plan sponsor before the end of the vesting period — to offset employer contributions violates multiple provisions of ERISA, according to global law firm Holland & Knight. 

"Three areas that the Department of Treasury says employers can use the forfeited funds for are, number one, administrative expenses, and that gets you on the very thin ice of excessive fee litigation," says Richard Clarke, chief insurance officer at Colonial Surety Company, which specializes in business liability insurance. "The second one is reduction of employer contributions under the plan, and then third, logically, increase the benefits and other participants' accounts in accordance with plan terms."

Despite clear opinions from the Treasury Department, some of these cases have gained ground. And while none of the suits have reached conclusion, they signal an opportunity for benefits professionals to double down on plan management, ensuring compliance with federal guidelines and updating their own company terms regarding retirement plans.

Employers should also note a layoff-size caveat: If a reduction of force impacts 20% or more of plan participants within a year, it may classify as partial plan termination, in which case all affected employees are to be automatically vested, and are entitled to receive the full amount of their 401(k). 

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What HR can do now

Clarke recommends employers consider investing in fiduciary liability insurance, which Traveler's Insurance explains as coverage that "helps protect companies from claims of mismanagement and the legal liability related to serving as a fiduciary." 

Additionally, education through thoughtful, repetitious communication can help employees better understand their retirement plans, Clarke says. HR professionals can focus on the advantages of investing, but also include what workers are entitled to should layoffs — or other circumstances that cause them to leave — occur. This can help employees plan better for their financial futures and clear up confusion that could cause issues for employers down the line.

"A lot of employees know they are participants in a 401(k) plan, but the word 'forfeiture' hasn't occurred to them, and vesting is a term that a lot of employees are not familiar with," says Clarke. "[They may think,] employers match my contributions by 5% — isn't that all my money?' It all goes back to what the vesting provisions say."

Clarke notes that if companies outsource their benefits administration to third parties, they should insist on a contract that states the administrator's role in employee communication throughout the year. He also advises employers to be intentional about the types of print and electronic messaging they provide, aiming for digestible amounts of information. 

"Do you want to highlight the key provisions, the employer matching percentage, the vesting period?" he says. "Could you make it even simpler and just do a single page that touts the benefits of the 401(k), depending on tenure, or how much money they're going to have under current conditions with the employee contribution, the employer match, and then interest rates that are earned. There's several different ways for the employee to benefit. And again, it's having the employee understand that."

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All plan sponsors should be putting safeguards in place to protect themselves, even if they don't see a present layoff risk, and they can use this as a great excuse to refresh their workforce on details of their benefits as well.  

"We hope that all employers want as many employees as possible to participate in an employer match," Clarke says. "The employer can say, 'Here's what we're trying to do to help you with your financial security long-term."