Vesting schedule

What a vesting schedule is

Vesting means ownership. Money an employee defers from pay, and its earnings, is theirs immediately. Employer contributions, such as a match or profit sharing, can be earned over time. The tax code allows two kinds of schedule for 401(k) employer contributions, and a plan can always be faster:

• Cliff: 0% until three years of service, then 100%.

• Graded: 20% after two years, rising 20% a year to 100% after six years.

Safe harbor contributions must be 100% vested when made. A QACA safe harbor contribution can use a cliff of up to two years.

Why it matters to employers

Vesting is a retention tool and a cost lever. Amounts that departing employees do not vest in become forfeitures, which the plan can use to pay plan expenses or reduce future employer contributions. The plan document also defines a year of service, usually 1,000 hours in a 12-month period, and you have to track it accurately.

Example

An employee leaves after three years with $10,000 of employer match in her account. Under a six-year graded schedule she is 40% vested, keeps $4,000 and forfeits $6,000. Under a three-year cliff she keeps all $10,000.

Common mistakes

• Applying the schedule to the wrong money, such as safe harbor contributions or employee deferrals.

• Miscounting service for rehires, or ignoring service with a related company or a predecessor employer.

• Forgetting the events that vest everyone fully: reaching the plan’s normal retirement age, plan termination and a partial plan termination after a large layoff.

• Paying out a departing employee using the wrong vested percentage.