The Employee Retirement Income Security Act of 1974 includes strict guidelines for employer sponsored retirement plans including 401(k)s. ERISA includes instructions for the vesting process through which retirement assets are transferred from employers to employees. Under ERISA rules, 401(k) plans must use either a cliff or a graduated vesting schedule.
You can contribute to your own 401(k) on either a pre- or after-tax basis through payroll deductions. Your own contributions belong to you and are immediately vested, as are account earnings. However, your employer's matching contributions are subject to vesting schedules as described in ERISA. Contributions made by your employer on your behalf technically belong to your employer until vested. Consequently, you lose non-vested money when you leave your employer or decide to retire.
Under the cliff vesting schedule, none of your employer's contributions to your 401(k) become vested until you have completed three years of service. At that point, the money is completely vested. Generally, your service begins on the day that you begin working for your employer. However, your employer can delay the start of service for vesting purposes if you begin work prior to reaching the age of 18 or if you opt not to participate in your 401(k) for a period of time.
Under the graduated vesting schedule, your employer's contributions are vested over the course of six years. None of the money is vested until you have completed two years of service, at which point 20 percent of your employer's contributions are vested. Thereafter, your employer's contributions are vested at a rate of 20 percent per year of service until the money is 100 percent vested during your sixth year with the company. Both the cliff and graduated vesting schedules detailed by ERISA are intended as maximums which means your employer may vest your money at a faster rate than either of the cliff or graduated timelines.
The original ERISA vesting guidelines enabled employers to use a 15-year graduated vesting schedule or a 10-year cliff vesting schedule. In 1988, these time frames were shortened to seven years for the graduated schedule and five years for the cliff vesting. The current guidelines for 401(k) vesting schedules took effect on January, 1, 2002. If you retired prior to the current vesting rules taking effect then your employer may continue to use the vesting schedule that was in place at the time of your retirement.