What Does Vesting Mean in a 401(k)?

You may not be entitled to all of your matching contributions

Depending on the terms of your 401(k) plan and its vesting schedule, should it have one, your employer may be able to retain some to all of the matching contributions it has made to your account. It can happen if you separate from your employment too soon.

Key Takeaways

  • An employer can require a certain number of years of service (called vesting) before its matching contributions belong to the employee.
  • Cliff vesting is when an employee goes from owning 0% of matching contributions to owning 100% after a certain period of time.
  • Graduated vesting is when employees own a growing portion of matching contributions until they're 100% vested.

401(k) Plan Vesting Schedules

The contributions you make to your retirement savings plan are always yours to keep. However, any employer-contributed funds may be subject to a vesting schedule. A vesting schedule is a provision of a 401(k) retirement plan stipulating that you must render a certain number of service years to your employer before you wholly own any employer contributions. Employers often use vesting schedules to increase retention. They limit your access to employer contributions until you reach a specified number of service years.

Employee vesting ranges from 0 to 100% depending on the length of service. If you are 0% vested, it means you are entitled to withdraw only those funds you contributed. If you are 100% vested, you own 100% of the funds in your account, including any employer contributions or interest that you have earned.

The inclusion of a vesting schedule means that if you separate from your employment before the required number of years of service has passed, you may be required to forfeit some or all of the money your employer has invested in your 401(k). If you elect to defer only the minimum amount to your retirement savings account, employer contributions may represent a significant amount of your balance.

There are circumstances under which an employer has the right to take back some or all of its matching contributions to an employee’s 401(k) plan.

Although the U.S. Department of Labor requires full vesting after six years of service, each employer dictates the specific terms of its vesting schedule. These terms can vary widely depending on the type of schedule the employer uses and its method of counting service years. While some plans allow for immediate vesting, many employers require that you complete at least one full year of service before you begin climbing the vesting ladder.

Cliff Vesting

One common vesting schedule format is cliff vesting. You must complete multiple years of service when you are 0% vested. After the allotted time has elapsed, the vesting percentage automatically jumps to 100%.

Assume your employer uses a cliff vesting schedule requiring five full years of work before vesting. After four years, your 401(k) balance is $12,000, composed of 50% payroll deferrals made by you and 50% employer contributions. If you decide to leave your employer for another job, you can only keep the $6,000 you contributed, because you have not completed the full five years of service required to attain full vestment. If you wait just one more year, all contributions to your 401(k) are yours to keep, regardless of your employment status.

Graduated Vesting

Graduated vesting schedules are a little less severe. You gradually increase your vesting percentage over time, rather than spending several years at 0%. However, employers may still require an initial period of service before vesting begins. A common graduated vesting schedule is an allocation of 20% for each year of service after the first year.

Assume the employer in the example above uses this type of graduated vesting schedule instead of a cliff vesting schedule. After four full years of service, you are 60% vested. If you decide to change jobs, you are entitled to the $6,000 you contributed and 60% of any employer contributions. In this example, the total amount you would be eligible to retain is $6,000 + ($6,000 * 60%), or $9,600.

Should You Stay or Should You Go?

Vesting schedules help employers protect their investment in current employees, making vesting a common provision of many 401(k) plans. However, if you are unhappy with your current employer, waiting to be fully vested can feel more like waiting for a hostage to be released.

If you are planning on leaving your employer before the plan's vesting period ends, check the specific terms of your 401(k) plan. If you have been contributing aggressively to your account, the amount of money you stand to lose to vesting requirements may not be enough to keep you in a dead-end job. This is especially true if you're moving to a new job with a considerably higher salary. If you rely on employer contributions to pad your retirement savings, an understanding of vesting requirements can prevent unnecessary forfeiture of necessary funds.

If a company is recruiting you aggressively and you stand to lose matching money, see if you can negotiate a salary and signing bonus that would "make you whole" if you leave. If they want you badly, you could get it.

How Do I Know If My 401(k) Is Vested?

Your employer will tell you the vesting schedule at the onset of your employment. If the company uses cliff vesting, the employer match portion of your 401(k) won't be available until a set period of time has passed. If the company uses graduated vesting, the employer match portion will be available at a certain percentage per year, as per the stated schedule. 

What Happens to My 401(k) If I Leave My Job Before I Am Vested?

In most cases, if you switch jobs before your 401(k) has fully vested, only the vested portion will go with you. The rest of the unvested balance in your account the company retains. 

How Many Years Have to Pass Until You Are Fully Vested in a 401(k)?

The number of years before vesting depends on the company and on what kind of schedule you are in, either cliff vesting, or graduated vesting. Many companies make you wait at least a year before any of the matching funds are vested.

Article Sources
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  1. U.S. Department of Labor. "FAQs about Retirement Plans and ERISA," Pages 4-5.

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