How Do 401(k) Vesting Schedules Work?

If you belong to a 401(k) plan you’ve probably heard the term “vested” mentioned somewhere along the line. But what exactly does it mean to be vested and how does a 401(k) vesting schedule affect the amount you have saved?

As it turns out, vesting can either have no effect at all or it can be extremely important. And I know that sounds crazy, but stick with me because today we’re going to teach you everything you need to know about 401(k) vesting rules…

Let’s dive in!

Rack of life vests to signify 401k vesting rules.

What Is 401(k) Vesting

Vesting is really just a fancy word that means ownership. You always own the vested portion of your balance and that can’t be taken away from you. But if you have unvested money too, then you haven’t earned full rights to that yet.

If that sounds confusing, hang with me a little longer. I promise it will make sense in just a minute…

How Does 401(k) Vesting Work?

When a company sets up a 401(k) plan, they can choose whether or not the company will make contributions to your account (in addition to the contributions you make yourself).

There is a lot of flexibility when it comes to how much match they can give you, but as an example let’s say they will match 50 percent of your contributions up to 6 percent of your salary. That’s a pretty common match amount but your company’s plan may offer more or less.

If you earn $50,000 per year and you contribute six percent of your salary ($3,000) to your 401(k). Your company matches 50 percent of that, or $1,500.

But they may not want you to get full ownership of that match right away. They want to hold on to talented employees like you, so to entice you to stay around longer they use a vesting schedule that requires you to work there for a number of years before you are fully bested in the match.

Let’s say you started working with your current employer just over a year ago and you started participating in the 401(k) plan immediately. Your employer matches 50 percent of your contributions up to 6 percent of your salary, which is a pretty common employer match.

Now remember: you’re always fully vested in whatever money you put into your 401(k) account yourself. That includes contributions that are automatically deducted from your paycheck and any amounts you roll over from another 401(k) you had with a previous employer.

None of that money can ever be taken away from you. The vesting schedule only applies to contributions made by your employer.

Types of 401(k) Vesting Schedules

The IRS allows employers to choose from a number of different 401(k) vesting schedules, and you’ll need to check your own plan’s specifics to see which one your employer uses.

First of all, if your company doesn’t offer a match at all then there is no vesting schedule to worry about. You’re always 100 percent vested in your own contributions and since there’s no match there’s no need for a vesting schedule.

Some 401(k) plans offer immediate vesting, which is awesome.  That means you don’t need to meet any service requirements at all and the employer match belongs to you immediately.

But most plans aren’t so generous and they make you stay with the company for a certain period of time before you “own” the employer contributions.

If you leave before you are fully vested you’ll forfeit, or give back, the unvested portion of your 401(k) account.

There are two types of 401(k) vesting schedules that can be used by a plan: cliff vesting and graded vesting.

Cliff Vesting

They call it cliff vesting because it’s all or nothing. You start out at zero vesting and then after a certain amount of time, BAM! your become fully vested in your account. (Don’t actually jump off a cliff to celebrate!)

The maximum amount of time your company can make you wait to become fully vested is three years. Of course, if they want they can be more generous and offer full vesting at just one or two years.

At first glance, cliff vesting sounds like the best option because you’ll reach 100 percent vesting in just a few years. But if you leave the company before you reach that vesting point, you’ll forfeit all of the employer contributions. Boooo!

Graded Vesting

With a graded vesting schedule, you start off at zero percent vesting and become more vested the longer you work there. Under this method, vesting is gradual and it may take several years before you are fully vested.

Here’s an example of a typical graded vesting schedule:

Years of Service with EmployerVesting Percentage
10%
220%
340%
460%
580%
6100%

Your plan’s 401(k) vesting schedule may be more generous than this example, but thanks to the Pension Protection Act of 2006, it can’t be any more restrictive.

Exceptions to 401(k) Vesting Rules

Even if your company’s 401(k) plan includes a vesting schedule, there are some exceptions to the rules.

Sometimes a company realizes it can’t afford the cost of operating a 401(k) plan, or the company goes out of business or gets acquired by another company. If your company decides to terminate the 401(k) plan, all participants become 100 percent vested automatically.

Also, all employees must become 100 percent vested when they reach normal retirement age. This provides an obvious advantage to someone who starts a new job shortly before retirement age. So if your normal retirement age is 65 and you star working at 63, you will become fully invested in just two years even if the company uses a six-year graded vesting schedule.

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