Retirement plans are a common benefit that employers offer. Some employers offer matching contributions for some of these plans. Employees should ensure they understand how those contributions work because they aren’t of any use to the employee until they’re vested.
Vesting refers to the degree of ownership an employee has over the funds the employer contributed to the employee’s 401(k) account. This is a critical aspect of retirement planning because it affects how much of the employer-contributed funds an employee is entitled to upon leaving the company.
Understanding vesting schedules
In many 401(k) plans, employee contributions are immediately vested, meaning the employee always owns 100% of their contributions. However, employer contributions are subject to a vesting schedule, which dictates how and when these contributions become the employee’s property.
Generally, two types of vesting schedules are applied to employer contributions: cliff vesting and graded vesting.
Cliff vesting allows employees to become 100% vested after a specified service period, typically three years. Employees who leave the company before completing the requisite period forfeit the employer-contributed portion of their 401(k).
Graded vesting allows employees to gradually become vested over time. For example, an employee might be 20% vested after two years, 40% after three years, and so on, until fully vested. This schedule provides a gradual increase in the amount the employee owns from the employer’s contributions based on their years of service.
Employees should consider the impact of vesting on their overall retirement strategy. The timing of a job change and the vesting schedule specifics can influence the retirement savings they will have at their disposal. Legal action might be necessary if the contributions aren’t vested as required.