You’ve got the ideal job—fulfilling work, great co-workers and a healthy salary and benefits, including a 401(k) with an employer-sponsored match. While that last perk may seem like simple, free money, be aware that there is likely one significant string attached—a vesting schedule.
This is essentially a waiting period that requires a certain number of years of service to the company before this free money becomes available to you. The longer you’re a loyal employee, the higher the percentage of company funds that are vested and become permanently yours.
As you map out your career path, and eventual retirement, understanding vesting and its implications is crucial to healthy financial planning.
How It Works
The term “vesting,” quite simply, means ownership. Every year, you will own (or “vest”) a certain percentage of the money in your 401(k)—typically 25 to 33 percent annually. If your vesting schedule is five years, for example, then you receive 20 percent of the total employer-matched funds each year. If you quit or are fired, say, after three years, you will only be 60 percent vested and will therefore only receive 60 percent of those funds.
Why do most companies impose such a schedule on their staff? Mainly to provide an incentive for their employees to stay with the organization. There are several ways they go about doing this:
- Immediate vesting. Only 46 percent of employers offer this option, for which you own 100 percent of the company’s contributions as soon as they are made. These funds are permanently yours, untouchable by the company once they’re given. And they follow you to your next job.
- Graded vesting. Far more common than the immediate option, you vest gradually over time, usually five or six years.
- Cliff vesting. As the name suggests, for this option you must wait to vest until the entire time period has passed—typically one to three years—at which point you receive the funds all at once (or leap off the cliff, as it were). Not surprisingly, this scenario tends to appeal to employers more than employees.
And there is one more string attached to this free money: Even once you are fully vested in your employer’s 401(k), you most likely need to wait for retirement in order to actually spend any of it, or risk a penalty.
Before You Change Jobs ...
When an exciting new opportunity pops up, check with your prospective employer about its vesting schedule to be sure it aligns with your goals. This should be a fairly easy question for HR to answer.
It’s also wise to weigh your potential new salary against the terms of the new 401(k). If you’ll be making significantly more money, then perhaps a slimmer 401(k) is acceptable. On the other hand, a generous plan can make up for less compensation.
Likewise, the decision to leave your current job should take into account how close you are to being fully vested. If that day is only six months to a year away, it might be worth it to hold on just a little longer.
Ready to Rollover?
When you do move on to the next stage of your career, you will, at some point, probably have to roll over your previous employer’s 401(k) to either your new company’s plan or to an IRA. Make sure that you are fully vested before you make the move, or risk letting valuable retirement income slip through your fingers. This can take up to five or six years.
A Simple Step
There are many complicated pieces in the retirement puzzle, but vesting doesn’t have to be one of them. Once you learn the basics, it’s mostly a matter of monitoring your progress toward being fully vested and making smart decisions accordingly about when and how to make those career transitions.
There are many resources out there to guide you in this process. Our e-book, Your Guide to Popular Retirement Plans, is a good place to start.