Pensions are a way for employees to accrue savings and benefits while they work, and then use those savings and benefits after they retire. Pension benefits are considered vested if the employee can leave the employer and yet still be entitled to receive the benefits from the employer.
Defined Benefit Plan
There are two basic types of pension plans. The first is a defined benefit plan, in which the worker accrues benefits commensurate with length of service to the company and salary received. Defined benefit plans are usually not individualized; rather, the company will take the funds for all employee-defined benefit pensions, pool those funds and put them in a trust or other investment vehicle in order to protect and increase the pension funds. While the pension benefits already earned by the employee cannot be changed or reduced, a defined benefit plan will allow the employer to change the rate of its future contribution, with appropriate written notice (often 45 days) to the employee.
Defined Contribution Plan
The second basic pension type is a defined contribution plan. In this plan, employees have their own separate account in which pension benefits accumulate. The employees contribute to the plan, and the employer will often match the employees' contribution. Upon retirement, employees are entitled only to the amount of benefits in their individual account. However, the employer in a defined contribution plan may be able to suspend payments into the employees' pension for multiple years for business reasons.
An employee's pension vests when the employee earns the right to pension benefits, and can no longer lose the benefits by quitting. A given pension plan will follow one of two types of vesting. "Cliff vesting" is an all-or-nothing approach, in which quitting within five years of hire means you forfeit all pension rights, but staying more than five years means all of your benefits will vest. "Graded vesting" is more gradual; it allows a fraction of your benefits to vest each year until, after a number of years of service, you eventually reach 100 percent vested benefits. Federal law does not allow employers to demand more than seven years of service before all benefits are vested.
Vesting Period Considerations
The type of pension plan will influence vesting. Defined benefit plans can follow either cliff vesting or graded vesting as described above. Defined contribution plans are a bit different because they contain employee-contributed funds. Employees always have the right to all funds they've contributed themselves; they are immediately vested in such pension benefits. But most defined contribution plans do require a certain period of service before the employee also becomes vested in the amount contributed by the employer. Note that some defined contribution plans, including SEP-IRAs and certain 401(k) plans, do allow for immediate vesting in employer funds.
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