What Does It Mean to Be Vested in a 401(k)?

Daniel Penzing
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What Does It Mean to Be Vested in My 401(k)?

If you’re a vested employee, then your 401(k) contributions belong to you regardless of what occurs within your company. In other words, you don’t have to worry about your 401(k) becoming the company’s 401(k) if your company goes out of business.

As long as you’re vested in your 401(k), you have control over your 401(k) assets.

This is especially relevant in situations where your company is dissolved or where you’ve left the company. In these scenarios, it’s important to know whether your contributions belong to you or your company.

Employer Matching Contributions

401(k) plans are defined contribution plans, which means that the contributions you make to your account are not necessarily guaranteed. All contributions are voluntary, and you can opt out at any time. The amount your employer contributes to a 401(k) account depends on your salary as of the plan start date and your 401(k) contributions.

While your contributions are deposited automatically, your employer matching contributions can be made at the time of payroll, or your employer can deposit the matching contributions into your account at the end of the year. If your employer makes matching contributions, the matching contributions can only be made up to the amount of the total employee contributions.

The types of contributions that employers make vary, but employers can choose to make full or partial matching contributions. Full matching contributions are required to be made if your employer offers a matching contribution, while partial matching contributions are optional.

Examples of employer matching contributions include employer matching contributions to the base salary deferral contribution, employer matching contributions to the base salary plus the number of hours worked (if your company offers matching dollars per hours worked…non-qualified matching contributions), and employer matching contributions to non-qualified matching contributions.

Employer matching contributions are part of the overall pension benefit that your employer provides. While your 401(k) account is portable, your employer matching contributions are not, and you may have to take them into account if you decide to leave your current employer.

Two Types of 401(k) Vesting Schedules

How You Get What You Earn

Whether you’re an employee who is vested in the plan or you are an employer who makes contributions to your employees’ plans, you have to know how the vesting schedule works in a 401(k). This is because as an individual or business owner, you have options to affect when and how much of that money is available to you.

As an employee, you will likely be on a vesting schedule that proceeds at a certain pace, and your employer might also include requirements for employer matching contributions (if they are even available). In order to understand how your 401(k) contributions will vest and when they will be available to you, you need to get familiar with a few key terms and terms of the vesting schedule.

It’s important to note that a 401(k) vesting schedule doesn’t directly affect your employer’s matching contributions. That component is based on different factors, and usually, you get the matching contributions right away.

So let’s look at the two types of vesting schedules, and then we’ll break down the details of each one.

Cliff Vesting

(What It Is and Why You Should Avoid It) The younger you are, the more important it is that you know about this vesting concept.

This is called cliff vesting, and it means old 401k plans that did not have to offer vesting at all.

Instead, they had a cliff wherein you would become 100% vested after only 3 years of service.

However, that same plan would withhold the matching contributions until the end of the cliff period.

In other words, you may have had to wait a full three years until you gained any interest, and you would only earn them when your match happened.

For example: Let’s say you started work on January 1, 2017.

The company offered a 401k plan, and you get 100% matching after 3 years of work.

In this example, you would gain nothing that year and nothing the following year.

As a matter of fact, nothing would happen until year three.

The company would withhold your matches until then; or if you left before then, they would have to return the money.

This is a system to avoid at all costs.

Now, it’s true that old 401k plans did not have to contain vesting provisions.

That is, if you left or switched companies, they could let you keep the money and have no further obligations.

Graded Vesting

Graded vesting means that your 401(k) account balance will grow as time goes on. You may have immediate vesting, which means that as soon as you start getting paychecks with your new company, you’ll be entitled to your 401(k) account.

You may have worked for your previous employer for a long time but haven’t been on the job for the requisite amount of time. This is the case for most people who have 401(k)s set up through their current employers.

In this case, if you leave your previous employer for a new job, you’ll need to work for a certain amount of time before you reach vesting. Depending on the company’s policies, you may need one year of service for every year that you want to vest. If you’ve been at the company for a longer period, you might not vest fully until you’ve been there a decade or more.

Whether you’re vested in your 401(k) ultimately depends on your employer’s policies and your agreement with your previous employer (if applicable).

In this chapter, we will discuss in details about precisely one of those items of daily life: mice.

Defining a “Year” for Vesting Purposes

In the private sector, a vesting plan is just one of the ways employers can ensure that employees are invested in the success of the business.

Under a vesting plan, employees receive company stock or other benefits over time rather than as soon as they begin working for the employer. They gradually earn the right to use this benefit according to a specific schedule. In the case of a 401(k) plan, the benefits being earned are retirement plan benefits rather than tangible perks such as paid time off or stock options.

Some forms of vesting are based on a schedule, while others are based on the completion of a specific event. Common vesting rules for retirement plans include a vesting schedule based on years of service or a vesting schedule based on the completion of a period of continuous employment.

Vesting events for retirement plans include the attainment of a certain age or the completion of a certain number of years of service. These events are based on the idea that the longer you have worked for the company, the more you should be committed to its success and the more you should receive from it.

Exceptions to 401(k) Vesting Rules

Vesting refers to when an employee begins to receive all of their employer matching contributions. Many employers offer 401(k) plans to their employees, and these plans include employer matching contributions. A lot of employers make these contributions on a vesting schedule. Vesting schedules are benefits detail documents that outline all of your 401(k) plan options and features.

The vesting schedule describes when an employee begins to receive employer matching contributions. For most types of vesting plans, employees do not receive employer matching contributions until they have been with the company for a specific amount of time (usually a year). In most vesting plans, an employee is 100 percent vested after two to five years of employment.

If the company offers you a 401(k) plan, they will usually have a vesting schedule to go along with it. There can be many different option vesting schedules based on the company’s preference. Most of the time, the fluctuation is a choice of 100 percent vesting for two to five years, or partial vesting in the first year and then full vesting at completion of the first year. Although, legally it doesn’t have to be this way. If you get a vesting schedule either from your employer or from plan providers, the text of the vesting schedule may say the following:

The Impact of Vesting on 401(k) Loans

If you are thinking of taking money out of your 401(k) to use for a down payment on your next home, you might be wondering how to make the timing work with the loan and vesting.

Well, depending on whether or not the loan is a regular loan or a hardship withdrawal, there are easy answers.

Hardship Withdrawals vs Regular Loans

Different people use their 401(k)s in different ways, based on needs. For example, some might use their 401(k)s to help pay for emergency expenses, namely medical expenses. Others might choose to use their 401(k)s to pay off credit card debt or student loans. Still others might use their 401(k) to help finance the purchase of their first home.

In most cases, a person can only loan money out of their 401(k) for a specific reason. In most cases, the reason a person can loan out money is because the loan is considered a hardship withdrawal. Hardship withdrawals are often given a pass when it comes to vesting.

Does a Vesting Schedule Mean the Employer Match Isn't Worth It?

Vesting in a 401(k) means that you have a right to keep all of your employer's matches. If you vest completely, this allows you to keep the full amount of your 401(k).

However, if you work for a company with a plan with a vesting schedule, there will be different timings to consider.

A traditional vesting schedule gives employees all of their matching funds early on in their careers, but requires employees to keep their jobs for a few years before they get 100% of their funds. This gives companies the flexibility to make larger contributions to help get workers started, then slowly increase the percentage of matching funds over time, as employees continue to give the employer value.

Some companies offer a graded vesting schedule. This gives employees more money up front in addition to having a longer vesting period of time.

If the company offers your first three months of vesting, then 15% by the end of a year, then 20% at the end of the following year, you get 25% vested after one year of employment. If you leave after that, you get 25% of your matches, but 75% of your employers contributions went to your coworkers that continued to stay engaged in the company's 401(k) plan.

Using the Employer Matching Contribution to Determine Your Own 401(k) Contribution

Where your 401(k) match will come from.

If you are lucky enough to work for a company that offers matching 401(k) contributions, you should always take advantage of that company. Simply put, for every dollar that you contribute into your 401(k), your employer will match that dollar, up to a certain percentage of your salary.

A maximum 401(k) company match is in place.

Many companies have a maximum limit on the amount of matching contributions that they can afford to give to each 401(k) contributor. If this is the case, then it’s up to you to contribute at least that limit so you get the full match.

Determine your contribution rate.

You should be contributing at least as much to your 401(k) as your company matches. So once you’ve calculated how much it will cost you to reach the maximum company match (if your company offers one), look at your current salary and decide how much you’re willing to contribute to it each month. The next step is to calculate the amount that you can contribute without changing your lifestyle.

Calculate the percentage yield on your 401(k) contributions.