A vesting schedule in a 401(k) plan refers to the process by which employees earn non-forfeitable rights to employer contributions made to their 401(k) accounts. In simpler terms, it’s the timetable on which an employee becomes entitled to keep the employer’s contributions to the 401(k) plan, often based on the length of their employment.
There are several types of vesting schedules:
- Immediate Vesting: The employee is entitled to 100% of the employer contributions immediately upon the contribution being made.
- Graded Vesting: The employee’s ownership of the employer contributions increases gradually over time. For example, an employee might become 20% vested after two years, 40% after three years, and so on until they are fully vested.
- Cliff Vesting: The employee becomes 100% vested after a certain period of service; before that point, they are 0% vested. For example, an employee may be 0% vested for the first three years of employment and then become fully vested after the third year.
The purpose of a vesting schedule is to provide an incentive for employees to remain with the company. Under U.S. federal law, there are limits to how long a vesting schedule can last. Generally, under a graded vesting schedule, an employee must be at least 20% vested by the end of their second year, reaching full vesting by the end of the sixth year. Under a cliff vesting schedule, an employee must be fully vested by the end of the third or fourth year, depending on the plan.