What Is Vesting?

Vesting refers to ownership. With a retirement plan, vesting is the process through which an employee gains ownership of their employer-contributed retirement funds. Vesting can also apply when it comes to employee stock ownership plans.

Here’s how retirement plan vesting works:

When you pay a percentage of your paycheck into your retirement account, your employer may match part or all your contributions. However, there may be limitations on when you can access that money. Oftentimes, employees will only own their employer’s contributions after they have been at the company for a specific period of time, and the funds have become fully “vested.”¹

When someone is 100% vested, this means that they will have complete ownership over the assets in the retirement account, even the amounts that may have been contributed by their employer. However, if you’re only partially vested, you may only have ownership over part of the assets. This means if you were to leave your job, you may forfeit some of the assets.

There are a few different reasons many employers implement vesting periods.

First and foremost, different retirement accounts may have different vesting periods. An Individual Retirement Account (IRA), such as Simplified Employee Pension (SEP) and Savings Incentive Match PLan for Employees (SIMPLE) requires all contributions to be 100% vested. On the other hand, profit-sharing or 401(k) plans) can offer a variety of different vesting schedules.²

When it comes to employee stock ownership plans, vesting can encourage employees to remain at their company, encouraging longer tenure. Vesting may also motivate employees to perform well.³

Different vesting requirements may apply to employer contributions. This will vary, depending on the type of plan the employer sponsors. Vesting schedules typically include graded vesting, cliff vesting, or immediate vesting. Here’s how they work:⁴

• Graded Vesting
  Graded vesting is when an employee gains gradual ownership of their employer’s contributions in intervals over time. For example, they may reach 20% vested after working at a company for two years and eventually hit 100% vested in their sixth year.
• Cliff Vesting
  With cliff vesting, an employee becomes fully vested all at once on a specified date. For example, they may remain at 0% vested until, for example, four years of service. With this example, once they reach the four-year mark, they’ll be 100% vested.
• Immediate Vesting
  With immediate vesting, an employee gains 100% ownership of employer contributions.

Cliff vesting happens all at once at a certain time, such as after five years of service. Graded vesting, on the other hand, occurs in stages over time.

Here’s a look at an example of vesting schedules for both cliff vesting and graded vesting:

If you leave your job before you’re fully vested, you may lose access to the portion of the stock or retirement funds that are not vested. For this reason, it’s important to be mindful of when you resign or find a new employer.

For example, if you have $5,000 in your account and are only 60% vested at the time you leave the company, you may only receive $3,000 and leave behind the remaining $2,000. Depending on your situation, it may make sense to consider postponing your resignation until you’re 100% vested.

When it comes to vested funds, however, you’ll have options. Before you leave your job, you’ll want to consider the different ways that you may be able to transfer funds that are vested. This may include:⁶

• Doing Nothing
  If your 401(k) balance is large enough, you may be able to keep the account with your former employer and allow the funds to grow over time.
• Cash Out Your Funds
  You may also be able to withdraw your funds. However, you’ll want to consider the tax implications first before doing so.
• Move Your Funds Into a 401(k)
  If your new employer offers a 401(k), you may be able to transfer the funds there.
• Consider Opening a Rollover IRA
  If you won’t have a 401(k) plan or other retirement savings plan at your new place of employment, then you may be able to roll your funds into an individually sponsored IRA.

Whatever you do, make sure you don’t rush into taking action. Instead, make sure you do careful research and planning to ensure that you don’t end up losing money.