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If you’re a 401(k) plan saver, odds are you are getting a “match” from your employer. But there’s a catch — that free money may not belong to you yet.
About 98% of companies that offer a 401(k) plan make regular contributions to workers’ retirement savings, according to a survey by the Plan Sponsor Council of America, a trade group.
Some match workers’ savings rate — up to 3% or 6% of pay, for example. Others dole out a portion of company profits, regardless of savings rate. Some do both.
However, in most cases, workers don’t own this money right away due to “vesting” rules. (Vesting means ownership, in retirement parlance.)
Companies use different timelines, or vesting schedules, to determine how long it takes for savers to fully own the employer contributions.
In some cases, they must work at a company at least six years before the funds are theirs — and risk forfeiting some of the money — and investment earnings — if they walk away early.
A worker retains complete ownership of their match when it is 100% vested. (One important note: An employee always fully owns their own contributions.)
About 41% of 401(k) plans offer immediate full vesting of a company match, according to the PSCA survey. This means the worker owns the whole match right away — the best outcome for savers.
“Immediate vesting is rare,” said Ellen Lander, principal and founder of Renaissance Benefit Advisors Group, based in Pearl River, New York.
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The rest use either a “cliff” or “graded” schedule to determine the timeline.
For example, a saver whose 401(k) uses a three-year cliff vesting owns the company match after three years of service; they get 0% before then.
A saver with a five-year graded schedule owns 20% after year one, 40% after year two, and so on until reaching 100% after the fifth year.
For example, someone who gets 40% of a $5,000 match can walk away with $2,000 plus 40% of any investment earnings on the match.
Federal rules require full vesting within six years.
About a third of 401(k) plans use a graded five- or six-year schedule for the company match, according to the PSCA survey. This formula is most common among small and midsize companies.
Vesting schedules tend to be a function of company culture and the philosophy of executives overseeing the retirement plan, Lander said.
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There are many quirks to 401(k) vesting rules.
For one, determining a worker’s length of service isn’t as straightforward as it might seem.
A “year of service” likely doesn’t equate to a full calendar year. Instead, it generally means 1,000 hours worked over 12 months, according to the IRS. (This formula amounts to about half a year of work for a full-time employee.)
This means a worker on a leave of absence could still satisfy a vesting requirement for the year, for example. However, companies use different definitions. Workers should consult their 401(k) plan documents for specifics.
“When we talk about years of vesting, what does a year mean?” Lander said. “There’s a lot of confusion — and disappointment or elation — sometimes as to what’s considered a year.”
Companies may also use different timelines for their match and profit-sharing contributions.
The match schedule is often faster than that of profit-sharing contributions. Companies may view the match as a benefit to boost employee savings and the profit-sharing payment as a financial incentive meant to encourage longer tenure, Lander said.
“We share it with you if you stick around to make us increasingly more profitable,” she said of the philosophy some companies adopt for their profit-sharing payment.
There are also instances in which a worker may become 100% vested, regardless of the length of their tenure.
For example, the tax code requires full vesting once a worker hits “normal retirement age,” as stipulated by the 401(k) plan. (For some companies, that may be age 65 or earlier.)
Some plans also offer full vesting in the case of death or disability.
Given the current competition for workers in the labor market, companies may seek to make their matching contributions more attractive to lure talent.
“Will vesting change given the new workforce, where employers are clamoring for people?” Lander asked. “Will you want to be the employer trying to hire someone and you still have a five- or six-year vesting schedule?”