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With a 401(k) plan, vesting refers to the process by which an employee earns the right to keep the employer’s contributions to their 401(k) plan. Here’s how it typically works:

  1. Employee Contributions: Any contributions that an employee makes to their 401(k) plan with their own money are immediately 100% vested. This means the employee owns these contributions outright from the moment they are deposited into the account.
  2. Employer Contributions: The vesting applies to the contributions made by the employer, such as matching contributions or profit-sharing. Employers use vesting schedules as an incentive for employees to remain with the company for a certain period of time.
  3. Vesting Schedules: There are several types of vesting schedules:
    • Immediate Vesting: The employee is entitled to 100% of the employer contributions immediately.
    • Graded Vesting: The employee becomes vested in increasing percentages over a period of time (e.g., 20% vested after one year, 40% after two years, and so on until fully vested).
    • Cliff Vesting: The employee becomes 100% vested after a specific period of service (e.g., 100% vested after three years of service).
  4. Forfeiture: If an employee leaves the company before they are fully vested, they may forfeit a portion or all of the employer’s contributions. The forfeited money typically goes back into the plan and may be used to reduce future employer contributions or to pay plan expenses.
  5. Legal Requirements: The vesting schedule must comply with federal regulations, which set maximum limits for vesting schedules to ensure employees eventually become vested.

Understanding vesting is crucial for employees as it directly impacts the amount of money they will have in their retirement account from their employer’s contributions upon leaving the company.