401(k) Vesting Schedules – What They Are and How They Work

Vesting is a retirement plan feature in which participants gain ownership over an employer contribution after a certain number of years of employment. Essentially, vesting is a way for employers to incentivize employees to stick around.

How quickly and how much employer contributions vest can be very different from plan to plan, and is determined by a “vesting schedule” in the plan document.

Below are answers to some of the most common questions we get on 401(k) vesting schedules.

Why Would I Want a Vesting Schedule in My Plan?

A vesting schedule helps incentivize employees to stay with the company. In addition, vesting schedules help reduce the cost of employer contributions over time, as employees who leave before their contributions are fully vested forfeit their right to the contributions, which can then be used to pay for plan expenses or fund contributions to other employees.

How Do I Know if My Plan Has a Vesting Schedule?

There are 3 places where you can able to find your plan’s vesting schedule:

  1. Your plan document in a section specifically dedicated to vesting
  2. In any sections of your plan document discussing employer contributions
  3. In your Summary Plan Description (SPD)

What Vesting Schedules Can I Select for My Plan?

The Internal Revenue Code (IRC) provides two acceptable vesting schedules 401(k) and profit sharing plans: three-year cliff and two- to six-year graded.  Under a three-year cliff vesting schedule, participants are 100% vested in the employer contributions when they are credited with three years of vesting service, but are 0% vested at all prior points.  Under two- to six-year graded vesting, participants are increasingly vested in the employer contributions with each passing year. The below chart shows the vesting percentages for both possible schedules.

Three-Year Cliff

Years of Service

Vested Percentage

0

0%

1

0%

2

0%

3

100%

Two- to Six-Year Graded

Years of Service

Vested Percentage

0

0%

1

0%

2

20%

3

40%

4

60%

5

80%

6

100%

Employers can adopt vesting schedules more favorable to their employees.  For example, an employer could have participants fully vest after two years (two-year cliff) or have participants increase their vested percentage by 25% per year for four years (4-year graded).  Both of these schedules are allowed, because participants vest faster under these schedules than they do under the IRC’s schedules above.

There is a special safe harbor 401(k) plan that provides for automatic enrollment, called a Qualified Automatic Contribution Arrangement (QACA). Employer contributions under a QACA may have a two-year vesting schedule.

What Events Will Cause Participants to Become 100% Vested?

There are 3 major events that will cause participants to become 100% vested:

  1. You terminate your company retirement plan
  2. A participant attains Normal Retirement Age, as defined in the plan document. Normal Retirement Age cannot be greater than the later of age 65 of the 5th anniversary of when the participant entered the plan
  3. If your plan has one, a participant meeting your Early Retirement Age provision would trigger them to be fully vested

Plan sponsors often choose to fully vest participants in cases of death or disability, but they are not required to do so.

Are There Any Contributions That Cannot Be Subject to Vesting?

Yes. Employer contributions made as a traditional safe harbor contribution – whether nonelective or matching – must always be immediately vested 100%.  Employee deferrals, Roth 401(k) contributions, rollover contributions, and employee after-tax contributions must also be 100% vested as soon as they’re made. 

Only non-safe harbor employer contributions can be subject to a vesting schedule.

What Happens if a Participant Terminates Who is Not Fully Vested?

Basically, the employee forfeits the non-vested portion of their account. 

For example, if an employee has $1,000 in their account and is only 60% vested at the time employment is terminated, receive only $600.  The remaining $400 is forfeited.  

If allowed in the plan document, forfeitures typically can be used to cover plan expenses, fund future employer contributions, or increase the accounts of the remaining plan participants.