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When you first signed up for a 401(k) or 403(b), you may have read something about when you’re “fully vested.” At the time, it’s likely you could’ve overlooked this term because you were overwhelmed with all the other financial jargon and having to pick out investments. But it’s important you understand vesting and how it impacts your retirement account.
Vesting is a term used in the financial industry to describe to what extent employees own the retirement funds contributed to by employers.
If your employer does not contribute, then you do not need to worry about vesting because your account only contains your contributions, which are always vested. If there is no employer match at your company, then you can just contribute to other retirement vehicles.
What is retirement vesting?
In retirement, “vesting” refers to when you own your retirement funds outright. You are always 100% vested in your own contributions. However, employers can choose different vesting schedules that encourage employee retention and don’t vest right away.
For example, if you contribute $5,000 to a retirement plan this year, you will be 100% vested, meaning you own the funds and if you leave the company, you still own the $5,000. If you contribute $5,000 to a retirement plan and your employer contributes a 5% match annually that vests on a schedule (not immediately), then you will only own the funds outright that are fully vested. This means that if you leave the company, you only get to take the amount of funds with you that are fully vested. You will forfeit any remaining contributions that are not fully vested when you leave the company.
Types of Vesting
There are three common ways your employer contributions will be vested: immediate, graded or cliff.
Employer funds are matched either immediately or over time. When they are matched and vest immediately, you are 100% vested and vesting really isn’t an issue. This is considered immediate vesting. Remember that any funds you contribute are always 100% vested. It is only employer contributions that can vest on a schedule.
When vesting occurs on a schedule, you don’t own the funds until they vest, which means that if you leave the company, you leave your funds behind.
Graded vesting means that you own your employer matched contributions in a percentage over time. For example, you may be 0% invested in year one, 20% invested in year two, and so on until year six when you are 100% invested. This means that if you leave the company in year three, you only get to keep the match that is vested, which would be 40% of employer contributions. This type of vesting is meant to encourage employee retention by rewarding you if you stay with the company.
Cliff vesting means that you own 100% of your retirement funds at some point in the future (compared to graded vesting that occurs partially over time). With cliff vesting, you may be awarded an employer match right away and not be vested until being there for three years. You may earn the funds in year one, but not be entitled to them until year three.
Determining how your retirement plan vests
You can find out how your retirement plan vests in a few different ways. For starters, you can contact your human resources department or office manger and they should be able to tell you.
You can also call the company that has custody of your account and ask. For example, if your retirement account is held by Fidelity, you can call Fidelity and ask a representative how your accounts vests. This information should also be available in your account dashboard.
A final way to get this information is in the Summary Plan Description that you should receive from your employer for your retirement plan.
With many different ways to find this information out, it should not be difficult and should be widely known in the company how vesting occurs in the retirement plan.
What happens when you leave your company?
If you leave your company before the employer contributions in your retirement account are fully vested and return to the company later, you may be able to count your prior years of service for vesting purposes. The rules are detailed, so always read your retirement account documents with respect to vesting.
When you leave your company, the retirement funds will typically be allowed to stay in that fund with your former employer (but not always). This is something you should find out about your specific plan. Alternatively, you can roll over your employer sponsored retirement plan into a personal IRA (investment retirement account/arrangement) or into your new employer’s plan. Both of these options, when done correctly, should avoid taxes and penalties.
With respect to vesting, when you leave your company, you will not be able to take any funds with you that have been granted but are not vested. If you leave after three years and your employer match does not fully vest for six years, then you can only take with you the amount that is fully vested (e.g. 40% of your employer match after three years). Employer contributions that vest on a schedule encourage employee retention and for this reason it rewards people who stay and punishes people who leave.
Don’t miss out on an employer match
The most important points to remember with respect to vesting are: 1) your retirement contributions are always 100% vested; 2) employer contributions may vest immediately, on a graded schedule, or on a cliff schedule; 3) if you leave your firm before your employer match is fully vested, you will leave money on the table; and 4) vesting is different at each company so make sure you find out how your specific plan works.
If you haven’t set up a 401(k) at all, but you know that you get an employer match, then be sure to set up an appointment with HR to start saving for your future self even if you are struggling with student loans.