If you're wondering what vesting means, it refers to the process of retirement plan participants meeting certain service requirements in order to fully own the retirement savings accumulated in their account. It’s commonly associated with 401(k)s and other types of plans to which employers may contribute on behalf of their employees.
You can take all the money with you – both your own contributions and your employer’s matching funds – if you’re fully vested and you leave your job for any reason, even if you’re fired. That’s the easy part. There are various types of vesting schedules, and you’re not fully vested until you work for your employer for that specified period of time.
How Does Vesting Work for a 401(k)?
You might take a job with a company that offers a 401(k) plan. You contribute some of your earnings to that plan each pay period, and your employer contributes dollars to your plan as well, at least to some extent. A company will usually contribute somewhere in the neighborhood of 3 to 6 percent if you contribute 6 percent of your earnings. Your company is “matching” your contributions.
This is often referred to as “free money,” but it’s only free if you become vested and get to keep all those extra employer contributions. It doesn’t necessarily become your money immediately at the time your employer contributes it.
According to the IRS, being fully invested means you have the rights to your entire retirement account balance. At that point, you won't ever have to worry about your employer taking back their contributions.
What Is a 3-, 6- or 7-Year Vesting Schedule?
You’ll become fully vested when you’ve worked a prescribed number of years, referred to as the "vesting schedule" or "vesting period." You own all the money in the retirement account when you’re fully vested. Pension plans can require as many as seven years of service, although SoFi indicates that immediate vesting upon hiring can be offered by some companies.
A Cliff Vesting Schedule
A cliff vesting schedule typically covers three years of service, according to Tax Deferred Solutions. You’d be fully vested when you reach “the edge of the cliff” after you finish your third year of employment with the company, but you’d lose your employer’s contributions if you left your position after 30 months. A cliff vesting schedule means you’ll become fully vested all at once at that 36-month finish line.
A Graded or Graduated Vesting Schedule
This type of vesting schedule typically covers six years of service. You’ll become a bit more vested incrementally over the years rather than all at once. Your percentage of ownership is “graded” or gradual.
You’d be 20 percent vested after you complete your second year of employment with the company, increasing to 60 percent after four years. You’d become fully vested upon completion of year six. You wouldn’t be vested at all unless you completed at least two years of employment, according to the Military Benefit Association.
A Milestone Vesting Schedule
A milestone vesting schedule is a whole different breed. It’s not based upon length of service but rather upon attaining certain goals or “milestones” in your job. This type of vesting is often used by young companies that are just starting out, and the matching contributions might involve stock options rather than cash. A milestone vesting schedule encourages accomplishments that will help the company grow, according to SoFi.
What Plans Require a Vesting Schedule?
Vesting schedules can depend on the type of plan your employer offers. Contributions to IRA plans are always immediately fully vested. Qualified defined contribution plans – such as profit-sharing plans, 401(k)s, 403(b)s and 401(a)s – are usually subject to vesting schedules over a matter of years.
Pensions and stock options might vest immediately, or they may vest according to a schedule.
Frequently Asked Questions
Does Vesting Start From the Hire Date?
Vesting schedules typically begin with your first day of employment, but you’ll want to check with your plan administrator or your human resources department to be sure.
What Happens if You Quit Your Job?
You’re immediately and fully vested in any contributions you’ve made personally to your plan. Employee contributions are automatically vested, so that’s your money. It’s your “vested balance,” and you can take it with you when you go.
However, you’ll typically forfeit at least a portion of your employer’s contributions if your job terminates before you’re fully vested. You might not lose all that money if you’ve been vesting on a graded schedule. You’ll get to keep a percentage of your company’s matches. The balance of the money is returned to your employer.
Are There Any Other Vesting Rules and Requirements?
Some vesting schedules require that you work a certain number of hours in each of the years, such as 500 hours per year for a period of five years, or even 1,000 hours over 12 months. The IRS requires that you must become fully vested at the time you reach full retirement age or if the plan terminates for some reason.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.