401(k)s – What is vesting?
[Photo: Puzzle tables. They’re everywhere in this pandemic. Ours’ arrived in March and became a fixture in our living room. It even traveled with us on vacation (you can buy puzzle carriers). I kinda feel like this is the best visual of how we are all trying to work through the pandemic. Remember: Eventually puzzles are finished and only then does it really make any sense. Hang in there!]
A great feature of 401(k)s is that most offer a matching company contribution. This is intended to help employees save for retirement and to encourage all employees to participate. Its free money! But how does this work?
A popular match formula is for your employer to match your 401(k) salary deferrals dollar for dollar ($1 for $1) up to 3% of pay and then $0.50 per $1 up to 5% of pay. If you put away 5% of your pay, this translates to a company contribution of 4% of pay. Your employer can choose to deposit the match with every paycheck (e.g. pay as you go) or, they can wait until the year is over and then put in a lump sum amount based on your contributions for the prior year.
When can I have my money?
Employee contributions are always 100% vested. In other words, you can always take out your own money when you leave your employer. But just because you see the company matching contribution on your paycheck doesn’t mean that you can withdraw that money. Normally, employer matching contributions are subject to a vesting schedule. In other words, a portion of these contributions become available based on the years you work at the company. There are two versions.
Three-year vesting
With three-year vesting, an employee must have three years of service before they become vested in their employer contributions in a 401(k) plan. If the employee terminates employment prior to completing three years of service, they are not entitled to any of the company matching contributions.
Three- to seven-year vesting
This vesting schedule is one of the most common in 401(k) plans:
Years of service | Vested amount |
0-1 | 0% |
2 | 20% |
3 | 40% |
4 | 60% |
5 | 80% |
6 or more | 100% |
Vesting under Safe Harbor Matching Contributions
The majority of 401(k) plans utilize Safe Harbor Matching. If your plan is set up this way, you are always 100% vested in your contributions and your employer’s contributions. Safe harbor rules help employers skip certain plan testing which can be complicated and expensive. In exchange, all employer contributions must be 100% vested to each employee from day one of employment.
Knowing how vesting works in your plan is important. Over time these company contributions can make a huge difference in the amount saved for retirement and when you can retire. Pay attention, it’s your money.
Still have questions about your 401(k)? Give us a call. We’re here to help.
Lyman H. Jackson
617-653-3303
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. FPS provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client after entering into an advisory relationship. Information herein includes opinions and forward-looking statements that may not come to pass. Information is derived from sources believed to be reliable. Information is at a point in time and subject to change without notice. Such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.