Many companies offer 401(k) matching programs which can be a fantastic perk for employees. However, the money the employer contributes typically isn’t the employees right away. In the majority of cases, there is a point when the funds from the employer contributions legally become the employees, and that’s where 401(k) vesting comes in. We are going to cover what 401(k) vesting is, the purpose, vesting schedules, and other common 401(k) vesting questions.
What is 401(k) vesting?
401(k) vesting is a term used to explain when the funds added to a 401(k) account by an employer permanently becomes the employee’s money. Until the money is vested, the employer has the right to take the funds back if the employee leaves the company.
The employee’s money is always their own, there is no vesting schedule for money that an employee adds to their own 401(k) plan. This term only describes money added by the employer as a match or flat contribution.
Fully vested means that all of the money that an employer adds or has added to a 401(k) plan is immediately the employee’s money. Once the plan is fully vested, money that has been added in the past as well as money that is added in the future belongs to the employee regardless of when they leave the company.
What is the purpose of vesting?
The primary purpose of a vesting schedule is for employee retention and performance. If an employer offers a 401(k) match, but adds a vesting schedule where the money does not fully become the employees for say, two years, the employee is much more likely to perform well and stay with the company for at least two years to be able to keep those funds.
What are vesting schedules?
The term “vesting schedule” refers to the amount of time, as well as the percentage of contributions that is scheduled to vest within a retirement account. Each company can set up their vesting schedule slightly differently, but there are IRS minimum vesting schedules that companies must adhere to. See below for details.
How long does it take for 401(k) to be vested?
The answer to this depends on your specific plan. Each plan can have a slightly different vesting schedule, however, there are minimum vesting schedules plans must adhere to.
The shortest vesting schedule an employer can use is an immediate vesting schedule. This means that as soon as employer money is put into an employee 401(k) account, the money is fully vested. The employee does not need to stay with the company for any length of time to keep the matching funds.
There are two other types of vesting schedules: Cliff and Graded.
A Cliff vesting schedule means that none of the matching funds are vested until an employee hits a certain amount of time with the company, at which time they are immediately 100% vested.
A Graded schedule means that each year the employee stays, they are vested in another percentage (for example, 20% per year) of their 401(k) until they are fully vested.
The longest cliff vesting schedule allowed is three years. In this scenario, if an employee leaves before three years of service, they do not get to keep any of the employer’s contributions to their 401(k) plan. But if that employee stays for at least three years, they now own 100% of the employer’s contributions to their 401(k) plan.
The longest graded vesting allowed is a six-year graded vesting schedule. In this scenario, an employee receives 20% vesting each year starting after two years of service until they are fully vested, which happens once they have completed 6 years. If the employee leaves after five years of service, they will get to keep 80% of the employer’s contributions to their 401(k) plan, and 20% will go back to the employer. Once they have completed six years of service, 100% of the employer’s contributions are now owned by the employee.
Plans can have shorter vesting schedules than the above examples, they just cannot make the vesting schedules longer. The above examples are the longest periods of vesting allowed by the IRS for matching contributions to a 401(k) plan. Your plan may have a different vesting schedule, so check with them to see what that looks like for you.
What is vested balance?
Vested balance is the amount of the 401K plan that belongs to the employee even if they leave the company.
How does a 401(k) become fully vested?
To become fully vested, an employee must complete the amount of time with the company that is laid out in the plan description.
What happens to 401(k) money that is not vested?
If an employee leaves a company before a 401(k) plan is fully vested, the company receives any unvested money back including interest earned. This is only money that the company added during the vesting period, the employee’s money always is owned by the employee and they can take it with them regardless of when they leave the company.
What does fully vested after 5 years mean?
If an employee is fully vested after five years, this means that they must remain with the company for at least five years to keep 100% of the company’s contributions to their 401(k) plan when they leave the company. If the employee leaves before the five years of employment, they will forfeit some or all of the company’s contributions to their 401(k) plan depending on what the vesting schedule says and how long the employee was employed.
Can a company take away your vested 401(k)?
Once you are vested in your 401(k), the funds are yours regardless of whether you leave the company or stay. The company cannot take away a vested portion of a 401(k) account as the funds are owned by the employee when they become vested.
How do I know if my 401(k) is vested?
The best way to find out if you are vested is to check with your plan administrator. Generally, when you log into your plan account, you can see your vested balance and your unvested balance listed. If this is not obvious when you log in, you can contact the plan administrator and ask which portion is vested and which is not.
You could also try looking at your employee handbook to see what the vesting schedule is. You can then determine if you have unvested funds in your 401(k) plan by knowing how long it takes to be vested and how long you have worked at the company.
The last thing you could try is to check with your HR department, as they might be able to tell you if you are fully vested in your plan.
While any employee contributions to 401(k) plans are fully vested, that may not always be the case for employer contributors. Understanding vesting and your 401(k)’s vesting schedule, is important to help you plan for your retirement and financial future. If you are interested in having a comprehensive financial plan, schedule a free discovery call with one of our fee-only financial advisors today.
Kayla Welte, AFC®, ChFC®, CFP®, has been helping clients maximize their finances since 2009. With a background in financial education & counseling, Kayla is passionate about helping people prioritize & reach their financial goals. Kayla is a Financial Planner at District Capital Management, a financial planning firm designed to help professionals in their 30s & 40s elevate their finances. Schedule a free discovery call.