401(k) Vesting & Finding Your Vested Balance
In employer-sponsored 401(k) plans vesting refers to the amount of contributions made by the employer that the employee is entitled to.
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401k Vesting Meaning
A 401k plan is an employer-sponsored retirement savings plan that allows employees to make tax-deductible contributions to an investment account. Some 401k plans award the contributors with matching contributions or profit-sharing incentives, increasing the amount an employee has in their account.
A vesting schedule shows when contributions made by the employer become property of the employee. Of course, an employee owns all of their own contributions from day one. But, in some plans, employer contributions are earned with longevity where matching provisions encourage employee retention.
The employer sets the vesting schedule and outlines it in the plan summary document, which is the main source of information about the company's 401k plan.
What Is a Vested Balance?
The vested balance is the amount that the employee can walk away with today. The funds that are not vested are returned to the employer if the employee terminates employment because the employee hasn’t yet met the time requirement to vest all funds 100%. For example, if the vesting schedule is six years, the employee would own 100% of the employer’s contributions at six years and one day.
Types of Common Vesting Schedules
Vesting schedules are established by employers when they create the 401k plan. Plan administrators track contributions and employee start dates to ensure that employees get the right amount of money. There are four types of common vesting schedules:
1. Immediate
In an immediate vesting program, employees are fully vested from day one. This is the simplest vesting schedule to administer.
2. Cliff
In a cliff vesting schedule, the employee must wait for a set number of years, and then the entire amount is immediately vested. A cliff vesting schedule might say that employees are 100% vested after five years of service.
3. Graded
A graded vesting schedule gives the employee a higher percentage of ownership with each passing year. For example, a six-year vesting schedule might say that in year one, the employee has no right to employer contributions. In year two, they are able to take 20% of those contributions. Each year the vested amount increases.
Here is a sample graded vesting schedule.
Years of Service | Vested Percentage |
1 | 0% |
2 | 20% |
3 | 40% |
4 | 60% |
5 | 80% |
6 | 100% |
4. Safe Harbor Vesting Schedule
Safe harbor plans are 401k plans that require that all eligible participants receive a fully-vested employer match equal to 100% of employee contributions up to 3% of annual salary and then 50% of an employee's additional contributions up to 5% of salary. The IRS requires all matching contributions to be 100% vested unless it is a Qualified Automatic Contribution Arrangement (QACA) which says the employee must be vested with no more than two years of service.
401k Vesting Regulations
Employers must follow IRS regulations about vesting. When the employee has vested funds in his account, employers are not allowed to take any part of that vested amount back, leading to employee forfeiture. When funds are not vested, they can be forfeited. Employees are always 100% vested with their own contributions.
Determining Vested Balance vs. Actual Balance
One's vested balance can be easily determined by reading your 401(k) statement or contacting the plan administrator. Information on the administrator can be found either on the statement or by contacting HR.
The actual balance is simply the total amount of employee and employer contributions made to the account – note that balances may go up and down depending on the investment chosen in the 401k.
Who Sets the Vesting Schedule?
The employer establishes the vesting schedule when they establish the 401k plan. The schedule is then incorporated into the 401k adoption agreement, making the rules uniform for all participants.
Why Do Employers Offer 401k Vesting Schedules?
Employers usually offer 401k plans to help attract and keep quality talent. Because the employer is essentially giving the employee bonus money for contributing, employers often want employees to be part of the organization for a minimum period of time to be eligible to take the employer contributions. Vesting schedules encourage employees to remain with the company for longer periods of time.
What Happens When I Leave Before Being Fully Vested?
If an employee leaves his job before being fully vested, he is forfeiting the unvested percentage of money that the employer contributed. The amount is contingent on the vesting schedule and how long the employee was with the company. For example, assume an employee is on a six-year vesting schedule, with 20% vested after year two. If the employee leaves, he forfeits 80% of the employer’s contribution.
Tip: Maximize the money an employer gives by contributing enough to hit their contribution cap. This is free money once an employee meets the vesting schedule.
What’s a Good Employer Match and Vesting Percentage?
A common annual employer match is 100% of the employee contribution up to 3% of one's salary. This means that if you contribute $50 in each paycheck, the employer will match that $50 up to 3% of the paycheck amount. That means that if an employee makes $2,000 per paycheck, the employer will match up to $60 per paycheck. Contributing only $50 doesn’t max out the free money an employee can get from the employer.
Bottom Line
When employers contribute to employees’ 401k plans, the employees are essentially getting free money for their participation. Employers protect this investment into their people by requiring a vesting schedule that says how long an employee must be on the payroll before they can keep 100% of the employer contributions.
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