401k Vesting Schedules
Contributing to your 401k plan is critical for affording your retirement. You save money on taxes now by contributing to this type of retirement plan. You also benefit because the earnings on your investment grow tax-deferred. In some cases, you also get an employer match. The employer match isn’t usually yours right away. Most employers require a certain number of years of working at the company in order to become vested.
What are 401k vesting schedules? It protects employers in the event you leave the company after a short amount of time. Your employer wants to offer you the benefit of a retirement plan, and they are willing to contribute to it. They also want to encourage you to stay employed at their company. They aren’t as likely to invest in short-term employees. Thus they created a vesting schedule so that over time, more and more of the money they contribute to your retirement plan becomes yours.
How does all of this work? In this post, we will walk through several different 401k vesting schedules so you’ll understand them when you encounter them.
4 Critical Things To Know About 401k Vesting Schedules
Your Money Is Your Money
When it comes to contributing money to your 401k plan, what you put into your account, is yours 100% of the time. For example, if you contribute $100 per paycheck into your 401k plan, that $100 is always yours.
So if in 6 months or 5 years, you decide to retire or leave your employer for another job, you can take that money with you. It is yours, no matter what. You never lose or forfeit it.
There Are Different 401k Vesting Schedules
While each company is free to set its own vesting schedule, there are 2 options that are very popular across many companies.
- 401k Cliff Vesting
With cliff vesting, you go from having 0% of your employers contributions vested to 100% after a short time. For example, you might have 10% vested after one year, 20% after two, 30% after 3, and then 100% after the fourth year.
- 401k Graded Vesting
With graded vesting schedules, you have a set percent vested annually over a period of time. So you might have 20% vest each year and then after the fifth year, you are 100% vested.
The Vesting Period Varies By Company
While the above examples are very common across employers in various sectors, not every company follows these schedules. They all make up a vesting schedule that makes the most sense for them.
For instance, one company might use a 20% vesting each year, and hence getting to 100% vested takes 5 years. At another company, they might be vested at 25% per year. This would mean that employees are fully vested after 4 years.
Be sure you inquire about your company’s vesting schedule. Then you know how much your employer is contributing to your 401k and when it becomes yours.
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If You Are Not Fully Vested You Will Lose the Company’s Contribution
What happens if you leave the company, get fired or retire before you are 100% vested? The answer is you will forfeit a portion of the money your employer contributes.
For example, let’s say your company uses a graded vesting schedule of 20% per year. You contribute $5,000 a year into your 401k plan and your employer contributes $1,000 a year. After two years, you leave to work for another company.
How much money will you have in your 401k plan if you leave your employment? You contributed $10,000 of your own money into your retirement plan, so 100% or all $10,000 is yours to take. Your employer contributed $2,000 but since you are leaving after 2 years, you are only 40% vested. This means that $800 of what your employer contributed to your 401k plan is yours.
In total, you take $10,800 with you in your 401k plan along with any of the gains or losses associated with these contributions.
In all, 401k vesting schedules are there to protect the employer. As long as you work for your employer for at least 5 years on average, you should be entitled to 100% of the money they contribute to your 401k plan.
But if you leave sooner than this, then you are only entitled to a portion of the money. Fear not, for your own contributions as all of the money you put into your account is yours, all of the time. But if you can be patient, the free money your employer contributes can be yours as well.