What Every Investor Needs to Know about 401(k) Vesting
401(k) vesting is an important concept all investors should understand. Knowing what vesting is, how it works, and what type of vesting schedule you have will help you make smart decisions when it comes to your 401(k) because you don’t always own your employer matching dollars right away.
What Is 401(k) Vesting?
Vesting simply means ownership when referring to a retirement plan and represents how much employer matching funds you own each year.
How Does 401(k) Vesting Work?
When you participate in your employer’s 401(k) plan, the company typically contributes a certain amount to your plan based on the amount of your annual contribution.
Vesting is your legal right to keep what your employer contributes as a company match.
However, each employer has its own requirements for vesting.
Depending on your plan’s 401(k) vesting schedule, you may not own the money your employer contributed until you are fully vested.
Any money you personally contribute is always 100% vested and is yours to keep.
If you are 100% vested, this means you own 100% of your 401(k) balance and your employer cannot take it back.
Should you change jobs before you are fully vested, depending on the vesting schedule, you will have to return part or all of the money your company matched.
When Do You Become Vested?
When you become fully vested depends on your plan requirements.
Some 401(k) plans require you to stay employed for a specific amount of time before the money the employer contributed to your match is yours. This is known as cliff vesting.
Others let you keep employer contributions as soon as they are made.
Many companies have graded vesting. For example, 20% might be vested after your first year working, 40% vested the second year, etc., until you are fully vested.
No matter what, once you become fully vested, the money is yours to keep.
What Are the Types of 401(k) Vesting Schedules?
It’s vital you understand which type of vesting schedule your company offers because should you decide to leave your job early, you may have to forfeit your employer matching dollars.
Take a minute to read the information below, and then check out the information packet provided to you when you signed up for your 401(k).
Your vesting schedule should be clearly spelled out. If you don’t see it in your info packet, make sure to ask your plan representative or HR department.
Here are three types of vesting schedules:
#1 Immediate
This means you own your employer contribution as soon as you receive it in your 401(k) account.
#2 Graded
A graded vesting schedule means you vest a certain percentage of your employer matching dollars in a set period of time, until you are 100% vested.
For example, 20% might be vested after your first year working, 40% vested the second year, etc.
By law, employers must vest employees at least 20% at the end of 2 years, and another 20% annually each year thereafter.
This means by the end of year 6 working for your company, you will be 100% vested for the company match.
If you leave the company after 4 years and your company has a 6-year vesting schedule, you will own 60% of the amount your employer has contributed if they vested 20% at the end of year 2, 20% year 3, and 20% year 4.
#3 Cliff
Some companies require you to stay employed for a specific amount of time before the money your employer contributed is yours. This is known as cliff vesting.
Employers have up to 3 years to vest employees in this type of vesting schedule.
If you were to change jobs after 2 years and your company required you to work for 3 years to vest the entire company match, you would lose that money your company contributed.
No Matter What, Don’t Forget to Do This…
No matter what type of 401(k) vesting schedule your company plan offers, it’s important to take advantage of the company match.
If you don’t, you may be leaving money on the table.
When your company matches what you put in out of each pay, up to a certain percentage, it’s basically FREE money to you.
And it may help you accumulate the amount of money you desire at retirement.
How much is your company putting into your 401(k) each pay, along with what you are putting in?
Are they matching 25%, 50%, or even 100% of what you are putting in up to a certain amount, like 3% or 6% of your pay?
Do you know the answer?
If not, contact HR or your plan representative, and find out today. Then, make it a point to contribute–at a minimum–what your company matches.
Want to maximize your 401(k) and keep more of your hard-earned money? Check out our no-cost guide 5 Mistakes You Want to Avoid with Your 401(k).
