Employers sometimes offer retirement plans, including a 401(k), to employees as part of a company benefits package. An employee uses the retirement plan to help map out his financial goals and save for retirement. Whether you become 100 percent vested in the funds held within a 401(k) will depend upon the vesting schedule of the employer and how long you work there.
A 401(k) is a type of retirement account known as a defined contribution plan. The employee contributes funds to the retirement account. These contributions are deducted from the employee's paycheck and can be made with either before- or after-tax dollars, depending upon the choices permitted within the plan. Contributions made to a plan are held in a 401(k) account. An employer may also make contributions to the employee's 401(k) plan.
Vesting describes the percentage of ownership an employee has in the retirement account. A 401(k) can contain money contributed by both you and your employer. When you contribute your own money to the account, you own those funds outright from day one. When your employer contributes funds, how long you remain an employee of the company may determine the percentage of ownership you will have in those employer-vested funds. If you are considered 100 percent vested, you are entitled to all of the funds in your 401(k) when you retire or leave the company.
The contribution plan details the vesting schedule, which is generally measured in terms of years. Companies use one of two methods to determine when an employee becomes 100 percent vested in a 401(k). Cliff vesting means the employee receives either none of the employer-contributed funds or 100 percent of those funds based upon years of service with the company. For example, if the company sets a cliff vesting schedule of three years, an employee who completes three years of service will become 100 percent vested in the employer-contributed funds. If the employee quits after two years of service, he will receive none of the employer-contributed funds. Some employers use a slight variation on the cliff vesting method. For those employers, the vesting period begins on the day the employee begins work, meaning the employee becomes 100 percent vested in employer-contributed funds right from the start.
Graded vesting is another vesting schedule used by some employers. Here, an employee receives a partial percentage of the employer-contributed funds, based upon the length of time the employee works for the company. The percentage starts at zero then increases in increments over a certain number of years until it reaches 100 percent. For example, if a company that uses graded vesting has established a six-year schedule, an employee has a vested interest of zero percent in year one, 20 percent in year two, 40 percent in year three, 60 percent in year four, 80 percent in year five and 100 percent in six. You would have to work for the company six years before you're 100 percent vested in your 401(k).