The Insider's Guide to 401k Vesting Schedules

If your employer offers a retirement account, you may be wondering about what happens to employer matching funds if you leave your job. The answer isn’t as straightforward as you might think, so it’s essential to understand what will happen to your 401k.

At CMP, we work closely with our clients to ensure they understand their 401k vesting schedule and how it will impact their retirement. That’s why we’ve created this guide to 401k vesting schedules and how they work, which is complemented by our retirement planning services for small businesses, where we offer additional support and solutions.

What is a Vesting Schedule for 401k?

In finance, vesting refers to ownership. When you’re vested in your 401k, you have full ownership of the funds in your account. Nobody can withhold them or take them from you.

Vesting comes into play because, in many cases, employers offer matching funds. That means employees contribute a percentage of their paycheck to their 401k, and employers match those contributions up to a set maximum.

Let’s look at an example.

At one point, it was common for employers to match contributions up to 6% of an employee’s salary (unfortunately, it's not as commonplace today). If you earned $100,000 per year, your employer might contribute as much as $6,000 to your 401k during the year. If, in your first year, you contributed $10,000, you would have a total contribution of $16,000 for that year. Of that total, 62.5% came from you, and the remaining 37.5% came from your employer match.

Vesting schedules apply only to contributions from your employer. Your contributions are fully vested as soon as you make them. Your company’s vesting schedule is the waiting period that determines when you will have 100% ownership of your employer’s contributions. You’ll need to understand your employer’s vesting schedule to plan for your retirement. Understanding this schedule is crucial for effective financial planning as you prepare for retirement.

How Retirement Vesting Works

Retirement vesting rules are set by employers and are based on the amount of time an employee works for the company. There are three basic types of vesting schedules.

Graded Vesting

Graded vesting allows employees to become increasingly vested in their retirement savings over a period of time. Here’s an example of a six-year graded vesting schedule.

The schedule above is the most restrictive graded schedule allowed by the Internal Revenue Code. Companies are not allowed to have a vesting period of more than six years.

Cliff Vesting

Cliff vesting is another common type of 401k vesting schedule. Here’s an example of how it works.

As you can see, employees with this three-year cliff vesting schedule would have no right to employer contributions until they worked at a company for three years. However, they would then own 100% of their 401k.

Immediate Vesting and 401(k) Contributions That Are Immediately Vested

Immediate vesting is the most generous vesting schedule because employees have full ownership of their 401k, including employer contributions. It’s also the simplest type of vesting schedule.

Any employer can allow employees to be immediately vested. Two specific 401k plans also allow for immediate vesting: Safe Harbor plans and SIMPLE plans. Both are designed for employers who can’t pass 401k non-discrimination tests to make fully vested contributions to their employees’ retirement funds.

It’s important to know the Internal Revenue Code's limitations on vesting schedules. The two common vesting schedules we’ve included represent the most restrictive options. Employers always have the option to implement more advantageous schedules for their employees. Understanding this schedule is crucial for effective financial planning as you prepare for retirement.

How Do Employees Become Vested in Their 401k Plans?

In most cases, employees become vested in their 401k plans by staying with the same company for a specified time. As noted above, the longest time an employer can make you wait for full vesting is six years.

401k Vesting Schedule Example

It may be helpful to look at an example of how vesting would work for an employee who received matching contributions. For this example, we’re not including any earnings on contributions.

As you can see, this vesting schedule would give an employee full ownership of all money in their retirement account at the end of four years of employment.

How Long Until I Am Vested in My 401k?

The answer to how long it will take to be fully vested in your 401k is complex because it depends on your employer’s vesting schedule. Here are a few of the most common scenarios.

1. Your employer offers a traditional 401k but has decided to fully vest employees immediately. Every contribution you make, plus matching contributions, will be vested as soon as it is in your retirement account.
2. Your employer offers a SIMPLE or Safe Harbor 401k, and all contributions are fully vested when they are made.
3. Your employer has a graded vesting schedule that adheres to the minimum vesting requirements in the Internal Revenue Code. You’ll be fully vested after you’ve worked there for six years.
4. Your employer has a cliff vesting schedule that kicks in after two years. You’ll be fully vested after two years of employment.

The best way to determine when you’ll be fully vested in your 401k is to review your employer’s vesting schedule.

Events That Can Lead 401k Participants to Become 100% Vested

In addition to their employer’s vesting schedule, three other events can lead to 401k participants being fully vested in their retirement plans.

1. They reach normal retirement age, which in 2024 is 67 years for people born in 1960 or later. You can read the full retirement rules here.
2. You meet your employer’s rules for early retirement.
3. Your retirement plan is either fully or partially terminated.

Waiting until you’re completely vested to leave your job or retire will allow you to take full advantage of your employer’s matching contributions.

The Impact of Vesting Schedules on Retirement Planning

Understanding your employer’s vesting schedule is a must for retirement planning, which can be quite complex. The goal is to make sure that you have sufficient income for your retirement, including your Social Security benefits plus Required Minimum Distributions from your 401k. Whether you have a graded vesting schedule or a cliff schedule, the details will help you make the best decisions for your retirement. For expert guidance, an experienced CPA can provide valuable insights.

Leaving money on the table is never a good idea when you retire. Our free retirement savings guide can help to demystify retirement planning terminology and provide strategies and tips to help you catch up if you have a late start on retirement savings.

Do I Lose My 401k Employer Contributions If I Get Fired?

One of the most common things employees ask about company contributions is whether those funds can be taken back if their employment is terminated, whether they’re laid off or fired.

Let’s start with retirement plans in general. The money you have contributed, plus any vested matching funds, is yours when you leave your company, regardless of whether you find another job, retire, or are laid off or fired.

Your employer will retain matching funds that aren’t vested and the gains on any unvested money in your account. However, they can’t keep your contributions or vested employer contributions for more than 60 days after you leave, regardless of the reason.

Conclusion

If you participate in an employer-sponsored 401k and receive matching funds, we recommend reviewing the vesting schedule to ensure you understand when you will be fully vested. This information will help you plan for a comfortable retirement.