Vesting

Vesting refers to the ownership of employer contributions in an employee's retirement plan. While your individual contributions are always 100% yours from the moment they are made, employer contributions may not be immediately earned. While many employers transfer ownership of employer contributions to employees immediately, others utilize a schedule to gradually transition ownership over a period of time. It’s the process by which employer contributions to your 401(k) become legally yours. 

See also: Cliff vesting schedule and graded vesting schedule.

What does vesting mean for your 401(k) funds?

For your 401(k) plan, a "vesting" schedule dictates the percentage of ownership of employer contributions in your account. Your own contributions, the funds deducted from your paycheck, are always 100% yours immediately upon contribution. However, any additional contributions your employer makes, such as matching funds or profit-sharing, may not be. Instead, these employer-provided funds become fully "vested," or owned by you, only after a specific period of time or upon meeting certain conditions outlined in the plan document. 

Until these employer contributions are fully vested, you will lose a portion of your employer contributions if you depart from the company (also called a “forfeiture.”)

What are common vesting schedules?

Vesting schedules can vary significantly from one employer to another, but generally fall into two primary categories, plus immediate vesting.

• Cliff vesting: With a cliff vesting schedule, an employee gains 100% ownership of all employer contributions only after completing a specific, predetermined period of service, with a maximum of three years. If an employee's employment terminates before this "cliff" date, they forfeit all employer contributions. 

• Graded vesting: Under a graded vesting schedule, employees gradually gain ownership of the employer contributions over several years until they are fully vested. A common graded schedule might involve an employee becoming 20% vested after two years, 40% after three years, and so on, reaching 100% after five years. The maximum vesting schedule period for graded vesting cannot exceed six years for most plans. 

  • Note: Qualified automatic contribution arrangement (QACA) safe harbor plans must vest required contributions within two years. Under a graded schedule, if employment ceases earlier than the maximum vesting period, the employee retains the percentage of employer contributions that have already vested. 

• Immediate vesting: Some employers offer immediate vesting, which means you gain 100% ownership of their contributions right away, with no waiting period or service requirement. This is the most employee-friendly type of vesting. All safe harbor plans must have immediate vesting of required employer contributions.

Understanding your company's specific vesting schedule is vital for planning your financial future and knowing the extent of your ownership over your 401(k) funds. The specific vesting schedule that applies to you is determined by your employer and detailed in your official plan documents, such as the Summary Plan Description (SPD). Always refer to your plan's official documents for the rules that govern your account.

Why do companies implement vesting schedules?

Employers incorporate vesting schedules into their 401(k) plans for a few strategic reasons.A primary motivation is to foster employee retention. By linking employer contributions to an employee's tenure, businesses create an incentive for individuals to remain with the organization for an extended period, thus promoting stability in their workforce. 

Vesting  also serves as a mechanism for employers to ensure a return on their investment in employee benefits; they are contributing to your retirement, and vesting helps ensure that this investment primarily benefits those who are committed to the company long-term.