When I first joined the workforce, there was a six-month waiting period for eligibility to contribute to my employer’s 401(k) plan. On top of that, I had to reach my one-year service anniversary before the company would match my contribution, and the vesting schedule for those contributions was a marathon rather than a sprint. My experience was not uncommon at that time. Thankfully, those days seem to be over. (At least for now!)
What is vesting?
For retirement investment plans in the United States, an employee’s personal contributions to their 401(k) plan are immediately vested. However, the employer’s contribution is not required to immediately “vest”. Once an employee vests in the employer’s matching contributions, the employee gains the right to keep the contributions, even when employment terminates.
Under the Employee Retirement Income Security Act (ERISA), employers may decide to delay the vesting of their contributions to the employee. However, according to a 401(k) benchmark compiled in 2015 by 401k Help Center, the long waiting periods I experienced early in my career are now an exception. The data they collected indicates that 60% of employers now offer new hires immediate eligibility in the 401(k) plan. In addition to instant eligibility, 40% of plans now provide immediate vesting for employer contributions. (So long, marathon!)
Vesting vs. eligibility: Employer vs. employee contributions
Vesting: Vesting refers to the schedule in which employer contributions (AKA “company match”) are released to the employee. This is set up, in theory, to increase retention and prevent employees from working at a company for just a few months and leaving with the employer contributions. The philosophy for most companies who implement vesting is that they are regularly contributing to their employees’ 401(k) accounts, but want to ensure that it’s a good investment, so they are waiting for those funds to be released and actually owned by the employee after the employee has worked at the company for a year (this is one example scenario, there are more below!).
Eligibility: Eligibility refers to who is allowed to have access to the 401(k) at all. For many of the same reasons above, companies may not allow an employee to set up and even make their own employee contributions for a certain period of time, or based on certain criteria. A common eligibility requirement is age (must be over 18 or 21 years of age). Another is number of hours or length of time worked, and typically, especially when combined with an age requirement, these restrictions mostly affect interns (high school or college students working temporarily for a company) or part-time workers. You can read more about these cases here: 401(k) Benefits for Interns and Part-time Employees.
Be sure not to get these two concepts confused! For example, all employee contributions vest immediately, but an employee may not be eligibile to contribute at all for 6 months, as I was. For both of these cases, a lot of the spirit behind the restrictions come from the fact that, historically, it was both very manual and expensive to get individual employees set up on a company 401(k) plan, so companies wanted to be sure it would be “worth it”, so to speak. Nowadays, 401(k) setup is much more inexpensive and automatic, so heavy eligibility and vesting requirements are no longer as common. Human Interest offers custom options for both vesting and eligibility and makes it easy for both employers and employees to set up incremental accounts.
Types of 401(k) vesting schedules
There are various types of company contributions, with varied vesting schedules. Some companies offer immediate vesting of their matching contributions. However, some plans have rules which allow employees to vest their employer-contributed funds based on a pre-determined schedule. For example, an employer might require that employees must work for the company for three years in order to vest. Or, the company can choose to have the 20% of the contributions vest each year over five years. Three types of common vesting options include:
Full, immediate vesting (required for Safe Harbor Match)
If your company provides a Safe Harbor match, the match amount you contribute to employees is immediately, 100% vested.
Cliff vesting schedule
Under a cliff vesting schedule, if an employee leaves prior to three years of employment, the match is not vested. After three years of employment, the employee is 100% vested, so any company contributions are the employees from that point forward.
Graded vesting schedule
With a graded vesting schedule, based on the years of service, an employee keeps a portion of the money the company has contributed. After six years of employment, all company contributions are the employee’s. Below is a common graded vesting schedule, according to the U.S. Department of Labor:
Year 1 – 0%
Year 2 – 20%
Year 3 – 40%
Year 4 – 60%
Year 5 – 80%
Year 6 – 100%
401(k) vesting options for employers
Depending on the vesting plan an employer adopts, it can allow a company to entice candidates to join their organization (immediate vesting), or it can serve as a reward and incentive for employees to stay with the company for a period of time (graded or cliff vesting). When compared with immediate vesting, using a vesting schedule will require more time and administrative calculation. However, a cliff or graded vesting schedule may serve to benefit the employer that struggles with high turnover rates by encouraging employees to stay until they are vested.
Should I make vesting a part of my 401(k) plan?
When deciding whether to choose a vesting schedule or immediate vesting, consult with your legal, financial, and 401(k) advisors to help analyze the best option for your company. Be sure that part of your analysis factors in the employee’s perspective. If your 401(k) plan has what feels like an unreasonable or uncompetitive vesting schedule, employees may determine that the plan isn’t worth their participation. Or they may opt to work for a company that provides immediate vesting or a schedule that better meets their retirement investment goals.
Keep in mind that you’re looking for vesting options that meet your business needs, budget, and goals while also adding value for your employees. Whether you’re a small business owner or the HR director for a company with fifty employees, you want to make a vesting selection that’s sustainable, successful and provides a competitive advantage for your organization.
If you’re looking for a great 401(k) for your employees, click here to request more information about Human Interest.