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Employer 401(k) plan contributions are a regularly-discussed perk. While you might have heard that you should max out your match and not leave free money on the table, much less is said about the fine print: The money your employer contributes to your retirement plan might be taken back if you leave your job too soon.
Key Takeaways
- Some companies make employees wait before they can become vested—that is, take ownership of the money that employers pay into 401(k)s. This can be a gradual transition, or the funds may be distributed all at once.
- The maximum time limits for becoming fully vested are six years with graded vesting and three years with cliff vesting.
- Employer contributions made to safe harbor 401(k) and SIMPLE 401(k) plans must be fully vested immediately.
- A 401(k) participant becomes 100% vested at normal retirement age, or if their retirement plan is fully or partially terminated.
What Is Vesting?
Vesting means ownership. It is a feature of retirement plans that determines when participants gain full possession of employer-matching contributions. With a 401(k), an employee pays a percentage of each paycheck directly into an investment account, and the employer may match part or all of that contribution.
Any money you deposit in a 401(k) is yours. Employer contributions are less straightforward. Sometimes they aren’t yours to keep until vesting requirements—that is, time served at the company—are met. This can happen gradually as you work more years, or all at once after a set number of years of employment.
Waiting to get fully vested isn’t an issue if you stick with the same employer. The only issue is if you part ways with the company before your employer’s contributions are vested. In that case, the funds deposited into your account by your employer may be taken away.
Important
Vesting schedules are designed to incentivize employees to stay with the company for a longer period of time.
Vesting Schedule Rules
Some companies make employees wait before they can take full possession of the money that employers contribute. Others instead offer immediate vesting, giving employees complete ownership of their employer’s contributions from the moment they are deposited. Other companies adopt a vesting schedule, outlining how much and when an employee is entitled to take employer contributions with them.
Employers do not have unlimited choices, however. The government sets strict guidelines with little leeway. There is a limit on how long companies can prevent employees from being vested. The Internal Revenue Code (IRC) states that employers are permitted to use one of two vesting schedules: graded vesting or cliff vesting. Each of these schedules comes with its own maximum time frame.
Graded Vesting Schedule
Graded vesting gradually entitles employees to a bigger percentage of their employer’s retirement contributions as they spend more years at the company. Here’s an example of how it works.
| Graded Vesting Schedule Example | |
|---|---|
| Years of Service | Percentage Vested |
| 1 | 0% |
| 2 | 20% |
| 3 | 40% |
| 4 | 60% |
| 5 | 80% |
| 6 | 100% |
Employers don’t need to abide by this exact schedule. They can, if they wish, choose to be more generous and speed up the time it takes an employee to become vested—such as, for example, implementing a four-year schedule that has a vesting increase by 25% per year.
One thing employers can’t modify is the six-year graded vesting limit. It is a legal requirement that company contributions become fully vested within that time frame.
Cliff Vesting Schedule
Cliff vesting is the other option that employers can offer. Rather than gradually vesting employees, this timetable delays vesting completely for up to three years and then hands over ownership of company contributions all at once.
| Cliff Vesting Schedule Example | |
|---|---|
| Years of Service | Percentage Vested |
| 1 | 0% |
| 2 | 0% |
| 3 | 100% |
Again, employers are free to be more generous than this and make the cliff after two years rather than after three. The schedule above shows the most severe a company can be.
Fast Fact
The maximum amount of time that a company can delay employees from becoming fully vested is six years with graded vesting and three years with cliff vesting.
401(k) Contributions That Are Immediately Vested
Some contributions must be 100% owned by the employee as soon as they are made. This rule applies to elective-deferral contributions, which constitute the money deposited from an employee’s paycheck into a retirement plan, and employer contributions made to safe harbor 401(k) and SIMPLE 401(k) plans.
Safe harbor 401(k) and SIMPLE 401(k)s are variants of the traditional 401(k). They’re not subject to the usual annual compliance tests, which helps companies avoid administrative burdens and cut costs. However, they do require all employer contributions to be immediately vested.
Events That Can Lead 401(k) Participants to Become 100% Vested
Certain events can give employees ownership of their employer’s matching contributions immediately. A 401(k) participant must be 100% vested:
- At full retirement age, which varies on a sliding scale between 65 and 67 years old, depending on when you were born
- In the event that the company retirement plan is fully or partially terminated
There are other circumstances that may prompt an employer to fully vest participants, such as in the case of death or disability. However, this isn’t mandatory.
Vesting Rules and ERISA
The Employee Retirement Income Security Act of 1974 (ERISA) sets the legal standards for vesting. Under ERISA, employers are allowed to choose between two the types of vesting schedules (i.e. usually cliff or gradual, mentioned above). ERISA sets maximum time frames to encourage fair and reasonable access to employer-funded retirement savings.
ERISA does not require employers to contribute to employees’ 401(k) plans, but it does mandate that if they do, the contributions must vest according to one of these approved schedules. This regulation prevents employers from setting arbitrary or excessively long vesting periods.
ERISA also requires that employers clearly communicate the vesting schedule to all eligible plan participants. This is typically done through the summary plan description (SPD), a document that outlines the key features of the plan. ERISA also imposes fiduciary responsibilities on plan administrators on things like recurring, regular reporting and compliance monitoring.
How Long Until I Am Vested in My 401(k)?
This depends on your company’s plan. Some employers offer immediate vesting, whereas others provide it gradually or all at once after several years of service. To learn about the vesting schedule at your company, consult your 401(k) documents or get in contact with your human resources representative or plan administrator.
What Happens to My 401(k) If I’m Not Vested?
Your employer’s contributions will eventually automatically become vested unless you quit your job or are laid off before the vesting schedule is complete. In these situations, any unvested money is forfeited and returned to the employer.
Do I Lose My 401(k) Employer Contributions If I Get Fired?
This question has generated a lot of debate. Generally, when an employee is fired or laid off, any unvested money is forfeited. However, mass layoffs may be treated differently. The IRC says that when a 401(k) plan is partially terminated “all affected participants must be fully vested in all amounts credited to their accounts in the plan.” According to the Internal Revenue Service (IRS), a partial termination is when there is a turnover rate of 20% or more.
The Bottom Line
It’s smart to be aware of your employer’s vesting schedule and the rules that govern it. Today you may love your job. However, there’s no guarantee that you’ll still feel the same way in three or six years.
Knowing where you stand makes it easier to make decisions about your future. This could mean hanging on for a few more months to become fully vested before switching jobs, or quitting because the benefits of moving on outweigh the lost contributions.
