Cliff vesting is the process by which employees become fully vested in their employer's retirement plan after a certain number of years have passed. When someone is vested in their retirement plan, it means they have ownership of the assets in their account. Cliff vesting allows employees to gain 100% ownership of their retirement accounts according to a set timeline established by the terms of the plan.
Learn more about how cliff vesting works if you have a 401(k) or similar employer-sponsored retirement plan at work.
Definition and Example of Cliff Vesting
A cliff vesting schedule transfers 100% ownership of the assets in an employee's retirement account to that employee once they've registered a certain number of years of service. In the case of a 401(k) plan, this includes the original contributions made by the employee through salary deferrals as well as employer-matching contributions and earnings on their investments.
Here's an example of how cliff vesting works. Let’s say you start a job that includes a 401(k) as part of your benefits package, and your employer follows a three-year cliff vesting schedule. This means that after three years of service, you'd be 100% vested in your plan.
But if you were to leave your job before year three is up, you wouldn't be entitled to any of the matching contributions made to the plan.
IRS requires employees to be 100% vested by the time they reach normal retirement age under the plan or when the plan is terminated.
How Cliff Vesting Works
Cliff vesting works by establishing a specific timeline for becoming fully vested in your employer's retirement plan. Per IRS rules, defined contribution plans, such as a 401(k) or 403(b), can have maximum cliff vesting periods of three years. In a defined benefit plan or pension plan, cliff vesting can have a maximum time frame of five years.
During year one, you would be 0% vested in the plan, assuming your employer chooses to make matching contributions. You'd also be 0% vested in year two. After year three, you'd be 100% vested in the plan.
Your plan can set specific guidelines as to what constitutes a year of service, though this is typically defined as 1,000 hours worked over 12 months, according to the IRS.
This type of vesting is different from immediate vesting or graded vesting. With immediate vesting, employees own 100% of employer-matching contributions as soon as those contributions are paid into their accounts. Graded vesting spreads out ownership gradually, with employees becoming vested by a larger percentage each year until they reach the 100% mark.
Let’s take another look at the previous example. Say your employer contributes a 6% match to your plan in year one, year two, and year three. Meanwhile, you defer $10,000 of your salary into the plan each year.
Assuming you complete the years of service requirement, at the end of the three-year period, you'd be 100% vested in the following:
- $30,000 in contributions you've made
- 6% match your employer contributed each year
- Earnings on those combined contributions
Cliff Vesting vs. Graded Vesting
Employers can structure workplace retirement plans to follow a cliff vesting schedule or a graded vesting schedule. Immediate vesting is also an option, though this is less common. With graded vesting, the employee's ownership percentage increases incrementally year over year until it reaches 100%.
Say you accept a job with an employer that follows a six-year graded vesting schedule. Here's what your account ownership might look like:
|Example of a Graded Vesting Schedule|
|Year of Service||Vesting Amount|
|7 and beyond||100%|
Cliff vesting and graded vesting offer two very different paths to 100% ownership of the matching contributions in a 401(k) or similar defined contribution plan.
With cliff vesting, you can be 100% vested at a faster pace, while it can take up to twice as long with graded vesting. On the other hand, if you were to leave your employer before your third year, you might still walk away with some of your matching contributions under a graded vesting schedule versus cliff vesting.
If you were to quit your job or be terminated before year three in a cliff vesting plan, you'd only get to keep the money you contributed and your earnings.
|Cliff Vesting||Graded Vesting|
|May be attractive for newer companies that want to attract top talent for the short term||May be attractive for established companies that have three- to five-year turnover rates|
|Allows for 100% ownership of retirement plan assets after a maximum three-year period||Allows for 100% ownership of retirement plan assets after a maximum six-year period|
|Employees who leave their jobs before becoming fully vested aren't eligible to receive any part of employer matching contributions||Employees who leave their jobs before becoming fully vested may be able to keep some of their matching contributions|
Talk to your plan administrator or check your plan documents to determine whether your employer follows a cliff vesting or graded vesting schedule.
- Cliff vesting allows employees to become fully vested in defined contribution plans within three years.
- Graded vesting can stretch out the vesting period to up to six years instead, though they can allow for employees who leave their jobs early to take some of their matching contributions with them.
- For employees who plan to complete at least three years of service before changing jobs, cliff vesting offers an advantage—but these plans can be costly for companies with high turnover rates.
- Contributions to an SEP or SIMPLE IRA must always be fully vested according to IRS rules.
IRS. “Retirement Topics—Vesting.” Accessed Dec. 21, 2021.
IRS. “Employee Benefit Plan: Explanation No. 2—Minimum Vesting Standards Defined Contribution Plans,” Page 10. Accessed Dec. 21, 2021.
U.S. Department of Labor. “FAQs About Retirement Plans and ERISA,” Page 4. Accessed Dec. 21, 2021.