Employees using 401k plans should take advantage of employee matching contributions but also be aware that ownership of these assets is not instantaneous. Graduated vesting schedules outline when an employee earns full ownership of matching funds. Individuals should read plan descriptions so they aren't surprised.
Graduated vesting is how an individual gains the right to employer retirement contributions to a 401k plan. Often the vesting schedule increases the percentage of the account balance that the individual is entitled to on an annual basis. For example, after one year of completed service, a company's graduated vesting schedule might entitle an employee to 25 percent of the company's matching funds in a 401k plan. Graduated vesting schedules vary by company.
The U.S. Department of Labor has rules governing graduated vesting plans for 401k accounts. The government requires that employees with 401k plans with graduated vesting schedules be entitled to 100 percent of matching contributions after six years of completed service if the company doesn't allow it sooner. The precise schedule of minimum vesting outlined by the Department of Labor is 20 percent of matching contributions after two years, 40 percent after three, 60 percent after four, 80 percent after five and full ownership the following year.
Tip: Read Summary Plan Description
An individual should carefully read an employer's 401k summary plan description. This document contains important details about the company's investment polices, account fees and vesting policy. The plan describes the type of vesting the firm offers and the specific schedule by which employees are entitled to matching funds. The summary plan description also provides a guide to reading account statements. Often account statements delineate a total account balance as well as the vested amount of funds.
Warning: Cliff Vesting
An employee should not assume that all vesting plans follow a graduated schedule. Cliff vesting is an alternative method of granting ownership. As with graduated vesting, the Department of Labor regulates cliff vesting. Employees with a retirement plan using cliff vesting are not entitled to any matching contributions during the first two years of service. But after the third year of employment, the worker is 100 percent vested. Companies that use cliff vesting believe it improves employee retention.