Employer matching of 401(k) contributions is a common employee benefit. If you work for an employer that matches 401(k) contributions, your retirement account can grow faster. For example, let’s say that your employer matches up to 5% of your 401(k) contributions one for one. If your monthly salary before taxes is $5,000 and you elect to contribute 5% each month (or $250) to your 401(k), your employer will also contribute 5% ($250) for a total of $500 for the month. Although your employer matched your contribution, you may not have full ownership of that contribution until the funds are fully vested. Whether you’re fully vested will depend on your employer’s 401(k) vesting schedule.

So, what does vesting mean? According to the Internal Revenue Service (IRS), “Vesting in a retirement plan means ownership. This means that each employee will vest, or own, a certain percentage of their account in the plan each year. An employee who is 100% vested in his or her account balance owns 100% of it and the employer cannot forfeit, or take it back, for any reason. Amounts that are not vested may be forfeited by employees when they are paid their account balance (for example, when the employee terminates employment) or when they don’t work more than 500 hours in a year for five years.” It’s important to mention that any funds you contribute are automatically fully vested.

401(k) Vesting Schedule

According to In some plans, your employer’s contribution will be vested immediately, which means that you’ll have full ownership of that contribution as soon as your employer deposits the funds into your 401(k). According to The Motley Fool, “The vesting rules are set by the IRS in order to ensure that employers can use vesting to help retain employees while still giving workers ownership of their retirement savings within a reasonable time.”

There are two main types of delayed vesting:

1. Graded vesting – a predetermined percentage of employer contributions vests each year over a set period of time. Per The Motley Fool, “If an employer chooses to use a graded vesting schedule, they must vest at least 20% of employer contributions at the end of two years and another 20% annually in subsequent years. The longest a graded vesting schedule can last is six years, at the end of which employees are 100% vested.”
2. Cliff vesting – you will become fully vested at a predetermined date, usually before your third year of employment. The time horizon of a cliff vesting cannot be more than three years.

Graded vesting and cliff vesting encourage employee retention because the employee has to work for a set time to be fully vested. Vesting timeframes are up to the employer’s discretion as long as they fall under the maximum vesting time allowed by the IRS. Check with your employer for their specific vesting schedule.

It’s important to note that any matching funds contributed by your employer after your vesting date are 100% vested from the day they’re contributed. Also, there are several scenarios in which your 401(k) becomes fully vested, no matter your employer’s vesting schedule:

1. You reach full retirement age, according to the Social Security Administration
2. If you meet your employer’s early retirement age provision
3. If the company terminates that retirement plan

What Happens If You Leave Before Your 401(k) Is Fully Vested?

When you leave your job and your employer’s matched 401(k) contributions are not fully vested, you leave without that money in your retirement account. It may not make financial sense to do this in some cases. However, there are more considerations than if your 401(k) is fully vested when considering if you should leave or stay at your job, including your mental and physical health and the job for which you’re leaving your current employer. You should be able to see if/how much of your current matched contributions are vested by accessing your account information.

Takeaway

If your employer matches the contribution to your 401(k) plan, be sure to read the fine print to know what 401(k) vesting schedule your employer utilizes. Will the employer’s matching contributions be vested immediately, gradually, or at a predetermined date? Nobody likes to leave money on the table—knowing your employer’s rules from the get-go can help you make better decisions about remaining at or taking any job.

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References

IRS (n.d.). Retirement Topics – Vesting. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-vesting

Frankel, Matthew, CFP. (January 3, 2023). 401(k) Vesting: How It Works. The Motely Fool. https://www.fool.com/retirement/plans/401k/vesting/

O’Brien, Sarah. (April, 14l 2022).  62% of workers view 401(k) employer match as key to reaching retirement goals. But they may wait years for those contributions to be their own. CNBC. https://www.cnbc.com/2022/04/14/62percent-of-workers-view-employer-401k-match-as-key-way-to-reach-retirement.html