What Is 401(k) Vesting and How Does It Work?

This article is provided for informational purposes only and should not be construed as legal or investment advice. Always consult with a professional financial or investment advisor before making investment decisions.

The majority of employers offer some sort of retirement plan benefit for their employees — 68% of employed Americans have access to an employer-sponsored plan — and the 401(k) is the most common plan type by far. 

401(k) accounts allow you to contribute funds pretax, earning you a valuable tax break in the current year. Plus, you can then invest the money and it can grow tax-deferred until you retire. 

401(k) plan details vary by employer. Some offer generous perks, including employer matching, in which case the concept of 401(k) vesting comes into play. But what is 401(k) vesting, and how does it affect your personal finances?

What is 401(k) vesting?

401(k) vesting refers to the amount of employer contributions in your account that you actually own, and would continue to own, should you leave your job. 

To understand this, it’s important to examine the two types of contributions to a 401(k):

Your own contributions come out of your paycheck. You own these contributions 100% — vesting doesn’t apply to these funds. Even if you leave your job, you’ll keep all the money that you contributed. 

Employer contributions arein the form of employer matching. With matching, the employer puts in some of their own money to match the money you put in. This is an optional perk that some employers offer and is like “free” money. Vesting applies to these funds, so if you leave your job before you are fully vested, you could lose some or all of it. 

401(k) vesting applies only to employer contributions. If your employer doesn’t offer matching, you don’t need to worry about vesting. 

How does 401(k) vesting work?

401(k) vesting is the process by which individuals become eligible for full ownership of the money that the employer has contributed to the employee’s 401(k). 

Each company uses a different vesting schedule. However, it’s common for employers to require workers to stay at the company for a certain number of years before becoming fully vested.

There are two types of vesting schedules:

Cliff vesting requires employees to work a minimum number of years before any funds are vested. For example, an employee may be 100% vested after three years of service. 

Graded vesting allows employees to earn a percentage of vesting funds after each year of service. For example, an employee may be 0% vested in year one, 20% vested in year two, 40% vested in year three, and so on.

To illustrate, let’s consider this example:

• Company ABC offers a 401(k) plan and matches 100% of contributions up to 6% of a worker’s salary

• The company has a three-year vesting schedule, wherein employees must work for the company for a minimum of three years to be fully vested

• Employee XYZ earns $50,000 per year and contributes $3,000 per year to their 401(k)

• Company ABC matches the $3,000 contribution each year

• After three years, the employee’s 401(k) balance will be $18,000 — plus whatever investment profits they’ve earned

• Since it’s been three years, the employee is fully vested and owns 100% of their 401(k) balance

If the employee were to leave the company after two years, they’d lose all the employer contributions ($6,000, in this case). 

This is just an example; each company and 401(k) plan has different details. Some have a tiered vesting structure, where employees become partially vested each year. Others have instant vesting, which means there’s no waiting period. 

How do I know my 401(k) is fully vested?

Your 401(k) will be fully vested once you’ve met the employer’s requirements. Each employer has different terms and conditions. To confirm your vesting status, check with your employer’s HR (human resources) department. 

Why do companies use 401(k) vesting?

The main reason that companies use vesting is to encourage employees to stay with the company longer. Workers will have an additional incentive to stick it out if they know they’ll lose “free” money by leaving. 

Remember, you always keep the money you contributed yourself; these funds aren’t subject to vesting. Even if you know that you won’t stay at a job long enough to become fully vested, it’s likely still worth contributing. 

When you leave an employer, you’ll still have access to your old 401(k). You can often roll it into a plan at your new employer, or transfer funds to a self-managed retirement plan. 

How can 401(k) vesting impact my personal retirement contributions? 

Your personal retirement contributions are 100% owned by you and yours to keep, even if you leave your job tomorrow. In most cases, the 401(k) will stay open and you can continue using it. You may also be able to roll the account over into a new 401(k) with your new employer. 

This means that any money you put into your 401(k) yourself — and any money that’s deducted from your paycheck — isn’t subject to vesting. 

Final thoughts

Vesting is important to pay attention to if your employer offers 401(k) matching. It’s wise to check with your HR department to get all the details. 

Last, remember that vesting doesn’t affect the money you’ve contributed yourself. You don’t need to worry about losing your own contributions if you leave a job early. 

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