Know the Impact of Your 401(k) Vesting Schedule

Your 401(k) vesting schedule determines how much your keep when you terminate

Cash in a jar marked 401k
••• JGI/Jamie Grill/Blend Images/ Getty Images

Whenever you make a contribution to your 401(k) plan, you should not be concerned about your 401(k) vesting schedule. You’ll never have to forfeit your contributions due to terminated employment. (Still, the value of your investments may increase or decrease based on market changes.) On the other hand, when it comes to the employer matching contributions you might receive, the same is not true. To reduce or even eliminate the possibility of forfeiting your employer matching contributions, be sure to learn and understand the vesting schedule and rules at your company.

What Is Vesting?

When you vest in your employer’s matching contributions, you obtain the legal right to keep the contributions. "Vesting" in a retirement plan refers to ownership. Specifically, you have reached the point in time that you can leave from (or be fired by) your company yet retain that contribution. 

As an employee you are always 100% vested in your own salary-deferral contributions to a retirement plan at work. The same concept applies with SEP and SIMPLE contributions made by an employer. Any contributions that you make with your own money are always yours to keep.

What Is Immediate Vesting?

According to a Vanguard analysis of 1,900 qualified retirement plans with more than 3.9 million participants, just under half (47 percent) of companies offered immediate vesting for matching contributions. An employee who is immediately vested in his or her account balance owns 100% of it, and the employer cannot forfeit it, or take it back, for any reason. For example, if your employer offers matching contributions, you have immediate ownership of the matching balance. With immediate vesting you can make a contribution today and even if you leave your employer tomorrow, you will be 100% vested in your contributions and the employer match.

There is another potential situation where your employer contributions will be 100% vested. If your company uses what is known as a “safe harbor match,” then you are 100% vested in that part of the company contribution.

But if your employer does not provide immediate vesting you will want to take time to understand how the vesting schedule works.

Vesting Schedules

While some employers offer immediate vesting of their matching contributions, their rules more commonly cause employees to vest according to a predetermined schedule. Since employees vest based on the amount of time they have been with their employer, for practical purposes you typically won’t be able to quit Friday and take the matching contribution money you received Thursday.

Broadly speaking, the two kinds of vesting schedules are graded vesting and cliff vesting.

Graded Vesting Schedule

With a graded vesting schedule, you vest in your employer’s contributions on certain anniversaries of your employment. If your employer uses a graded vesting schedule, it may be more generous than the one described below, but thanks to the Pension Protection Act of 2006, it can’t be less so:

  • After one year of service: 0% vested
  • After two years of service: 20% vested
  • After three years of service: 40% vested
  • After four years of service: 60% vested
  • After five years of service: 80% vested
  • After six or more years of service: 100% vested

Cliff Vesting Schedule

Like it sounds, a cliff vesting schedule means that for a period of time you won’t be vested at all. Then, like going off a cliff, you become vested all at once. Again, your employer’s cliff vesting schedule may be more generous than the one described below, but your vesting will occur as least as fast as the following schedule:

  • After one year of service: 0% vested
  • After two years of service: 0% vested
  • After three or more years of service: 100% vested

Remember, each employer offering an employer match vesting over time will have either a cliff vesting schedule or a graded vesting schedule, but not both.

Make sure you are aware of your employer’s vesting schedule especially before making any major decisions. Saving for retirement is important, so it’s unlikely you would ever want to voluntarily leave your job just before you were about to vest in a significant sum of employer matching contributions!

Updated by Scott Spann