Here’s a mini crash course on vesting in your retirement plan at work.
In its most general form, vesting means to earn the right to own asset or benefit over time. If you work for a company that provides a 401(k) match, you’ve probably heard terms like “vested balance” or “vesting period” floating around.
This blog post simplifies the jargon so you’ll clearly know what money is yours and what isn’t…yet.
What’s the “vested balance” in my account?
The vested balance in your 401(k) (or other employer-sponsored retirement plan) is your money. If you’d up and quit your job today, this is the amount you’d take with you.
Any money you contribute to your retirement plan counts toward your vested balance. Said differently, earnings that come out of your paycheck and into your 401(k) are always yours – no vesting required. Plus, any investment growth you earn on your contributed money is also always fully vested.
The part that requires vesting is money your employer contributes on your behalf. Usually, employer contributions come in the form of 401(k) matching or profit sharing. Any growth earned on employer contributions is also subject to vesting.
So, if your vested balance is lower than your total account value, this is a sign you’re not yet fully vested. If you resigned or were terminated from your job today, you’d be leaving the unvested portion behind.
Find comfort in the fact that any of your income placed in the account is always yours, even if you’d walk away from your job today. Don’t let this worry hold you back from contributing more of your paycheck.
In fact, your company 401(k) plan can be one of the most impactful and easiest ways to build wealth for your family.
Just because money appears in your vested balance, it doesn’t mean you can take it out of the account. Yes, it’s your money, but you’ll want to keep it invested in your 401(k) account (or comparable type of IRA) so the IRS doesn’t getcha with taxes and an early withdrawal penalty.
What’s a vesting period?
A vesting period is a period of time during which you’re not yet fully vested. Usually, this occurs over the first 3 to 6 years when you start at a company.
It’s estimated that at least 4 in 10 American workers changed jobs since 2020. If this is you, you’ll want to brush up on your vesting schedule rules!
The two most common types of vesting periods are cliff vesting and graded vesting.
Cliff vesting works like it sounds. If your employer offers a 3-year cliff vesting schedule in its 401(k), on the 3-year anniversary of your employment – BOOM – you’ll go from 0% to 100% vested (fully vested) overnight. Once you’ve reached this milestone, all contributions going forward are 100% vested. They’re no longer subject to a vesting period.
If you’re thinking of changing jobs and know your retirement plan is subject to cliff vesting, you’ll want to time it right if you’re close to vesting. Because you suddenly go from zero to 100, leaving at an inopportune time (like when you just have a few weeks or months to go) can move the needle.
Graded vesting happens more slowly over time. Each year you work for a company, a certain percentage of your account balance becomes vested. If your company offers a 6-year vesting schedule (which is common), vesting in your account would look like this.
- End of year 1: 0% vested
- End of year 2: 20% vested
- End of year 3: 40% vested
- End of year 4: 60% vested
- End of year 5: 80% vested
- End of year 6: 100% vested
Employers obviously like graded vesting because it stretches your vesting timeline. As an employee, however, I’d actually argue that graded vesting can be a disincentive to stay.
Let’s say you’re two years into working for a company and are only 20% vested, but you’re presented with a job offer for significantly more money.
In this scenario, most of the time you’ll be better off taking the higher-paying job and forgoing additional vesting. Staying at your current company and earning MEH internal raises just to be fully vested in year 6 probably isn’t a great trade off. (Run your own numbers, of course!)
Other creative ways exist that employers can structure their vesting periods, but you’re most likely to run into these two. It’s also important to note that legally, these are the longest time periods your employer can make you wait to have a fully vested balance.
How do I know if I’m fully vested?
If your vested balance matches your total account balance, that’s a sign you’re fully vested. When there’s a difference between the two numbers, you’re not yet fully vested.
You can also consider the amount of time you’ve worked at your company. If you’ve eclipsed your 6-year work anniversary, you can know without a doubt that you’re fully vested in your 401(k) plan. No vesting periods can legally be longer than 6 years.
If you’ve been at your company fewer than 6 years, get your hands on a document called the summary plan description. The summary plan description explains all of the features and rules of your 401(k) plan.
If you work for a big company, usually you can find your summary plan description within your employee benefit portal. If you work for a smaller business, ask HR for a copy. Employers are legally required to furnish employees with this document.
How vesting periods for equity compensation are different.
So far, we’ve been discussing the vested balance in your 401(k) plan (or other employer-offered retirement accounts). What about if you receive equity compensation at work?
Equity compensation is also (usually) subject to a vesting period. What’s different about equity comp versus your 401(k) is that its vesting period begins on the date you were granted the shares (or right to purchase them via options), not on the date you joined the company.
For example, I worked for a large bank in Pittsburgh that offered a 3-year cliff vesting schedule on its 401(k). When I was in my fourth year with the company, I began earning restricted stock units (RSUs) as part of my compensation.
Even though I was fully vested in the 401(k) plan, that had no bearing on my equity vesting. My RSUs were subject to their own 3-year cliff vesting schedule that was triggered on the date the shares were granted to me.
I had to work for the company for another 3 years to vest in those shares. Every year thereafter, assuming I’d continue to earn equity, I’d always need to work 3 more years from the grant date to vest.
Equity comp is a notorious cause of one-more-year syndrome. The rolling vesting creates golden handcuffs, because there’s never a point at which all of your equity comp will be fully vested. It’s always dangling in front of you!
The bottom line
Your vested balance shouldn’t be in the driver’s seat of your career, but timing your moves right can mean the difference of thousands of extra dollars in your pocket.
If you’re entertaining a new job that would require leaving before vesting, consider negotiating this into the offer from your new company. People actually do this! Trust me.
Remember that any money you contribute from your paycheck into your 401(k) is always fully vested. If you leave your company at any time, you keep this money. It’s only employer contributions that are subject to a vesting period, so don’t let this worry prevent you from contributing more to your retirement plan.
Finally, if you’re unclear on the vesting period rules in your 401(k) plan, get your hands on your company’s Summary Plan Description.
Send me a message when you have questions. I look forward to hearing from you!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult with your financial advisor.