What Is Vesting?
Vesting in a retirement plan refers to owning the funds in that plan. A 401(k) plan has two kinds of contributions—one that the employee makes and the other is the employer 401(k) match. You have a legal right to keep the contributions when you vest in your employer’s matching contributions. You’ve reached the point in time when you can leave or be fired by your company but retain that money.
Types of Vesting
Although some employers do offer immediate vesting of their matching contributions, it’s just as common that their rules force employees to vest according to a predetermined schedule. That prevents employees from quitting on Friday, taking with them the matching contribution money the company paid on Thursday.
What Is Immediate Vesting?
Approximately 48% of the defined contribution plans administered by the investment management company Vanguard offered immediate vesting for matching contributions in 2021, according to a study conducted by Vanguard. The employer can’t take it back for any reason. You can make a contribution today, and even if you leave your employer tomorrow, you’ll be 100% vested in your contributions and your employer’s match. Your employer contributions might also be 100% vested if your company uses a “safe harbor match.” You’d be 100% vested in that part of the company’s contribution. Other circumstances can demand that you become 100% vested immediately as well. The money is all yours by law if the plan terminates or when you reach the plan’s retirement age.
Graded Vesting Schedule
You vest in your employer’s contributions on certain anniversaries of your employment with a graded vesting schedule, typically becoming 100% vested after five or six years. Your schedule might be more generous than this example, but it can’t be more stringent, thanks to the Pension Protection Act of 2006:
After one year of service: 0% vestedAfter two years of service: 20% vestedAfter three years of service: 40% vestedAfter four years of service: 60% vestedAfter five years of service: 80%vestedAfter six years of service: 100% vested
Companies are legally permitted to wait two to six years to fully vest an employee using this schedule.
Cliff Vesting Schedule
A cliff vesting schedule is much like it sounds—you won’t be vested at all for a period of time, then, like going off a cliff, you’ll become vested all at once, which usually occurs after one to three years of employment. This type of schedule obviously favors the employer. Again, your company’s cliff vesting schedule might be more generous than this one, but vesting will occur at least this quickly:
After one year of service: 0% vestedAfter two years of service: 0% vestedAfter three years of service: 100% vested
Vesting of 100% is required after three completed years of employment. Any employer can use either a cliff vesting schedule or a graded vesting schedule, but not both.
The Bottomline
Make sure you’re aware of your employer’s vesting schedule before making any major career decisions. Saving for retirement is important, so you won’t want to voluntarily leave your job just before you’re about to vest in a significant sum of employer matching contributions. Of course, there are always exceptions, such as that a far superior job offer is on the immediate horizon, making it more likely that you’ll be better off in the long run.
