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Contributing to your 401k plan is critical for affording your retirement. In many cases you also
get an employer match. Unfortunately, that money is not always yours right away but 401k vesting schedules allow this become a possibility. So what are 401k vesting schedules? How do they work? In this post, I will walk you through the ins and outs of 401k vesting schedules so you won’t be surprised when you encounter them.
The original article has been edited here for length (…) and clarity ([ ]) to provide a fast & easy read
What are 401k vesting schedules?
It protects employers in the event you leave the company after a short amount of time. Your employer wants to offer you a benefit of putting money into your retirement plan, but they also don’t want you to take advantage of them by leaving with their money quickly. Thus they created a vesting schedule so that over time, more and more of the money they contribute to your retirement plan becomes yours.
#1. Your Money Is Your Money
When it comes to contributing money to your 401k plan, what you put into your account, is yours 100% of the time so, if in 6 months or 5 years you decide to retire or leave your employer for another job, you can take that money with you. It is yours, no matter what. You never will lose or forfeit it.
#2. There Are Different 401k Vesting Schedules
While each company is free to set their own vesting schedule, there are 2 options that are very popular across many companies. They are as follows.
- Cliff Vesting
- Graded Vesting
With cliff vesting, you go from having 0% of your employers contributions vested to 100% after a short time. For example, you might have 10% vested after one year and then 20% after year two, 30% after year 3, and then 100% after the fourth year.
With graded vesting schedules, you have a set percent vested annually over a period of time so you might have 20% vested each year and then after the fifth year, you are 100% vested.
#3. The Vesting Period Varies By Company
While the above examples are very common across employers in various sectors, not every company follows these schedules. They all make up a vesting schedule that makes the most sense for them. For instance, when I worked at a small business, they used a graded vesting schedule. The only difference was that instead of 20% vesting each year and getting to 100% vested after 5 years, they vested 25% a year. This meant that I was fully vested after 4 years.
Be sure to inquire about your companies vesting schedule so that you know how much of the money your employer contributes to your 401k plan is yours and when it becomes yours.
#4. You Can Lose Money When You Terminate Employment
What happens if you leave the company, get fired or retire before you are 100% vested? The answer is you will forfeit a portion of the money your employer contributes. For example, let’s say
- your company uses a graded vesting schedule of 20% per year,
- you contribute $5,000 a year into your 401k plan and your employer contributes $1,000 a year and,
- after two years, you leave to work for another company. How much money do you leave with…[from] your 401k plan?
- You contributed $10,000 of your own money into your retirement plan, so 100% or all $10,000 is yours to take.
- Your employer contributed $2,000 but since you are leaving after 2 years, you are only 40% vested.
- This means that $800 of what your employer contributed to your 401k plan is yours.
- In total, you take $10,800 with you in your 401k plan along with any of the gains or losses associated with these contributions.
Final Thoughts
In all, 401k vesting schedules are there to protect the employer. As long as you work for your employer for at least 5 years on average, you should be entitled to 100% of the money they contribute into your 401k plan but, if you leave sooner than this, then you are only entitled to a portion of the money. Fear not for your own contributions as all of the money you put into your account is yours, all of the time but, if you can be patient, the free money your employer contributes can be yours as well.
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