Regardless of age, employees and job seekers are thinking more than ever about saving for their future. 401 (k) plans are therefore a very attractive advantage and can be an important competitive tool to help employers attract and retain talent. And when a company sweetenes the 401 (k) plan with a matching or profit sharing contribution, it is like “free money” that can be difficult to overlook for potential or current employees.
However, employer contributions go hand in hand with the concept of “vesting”, which both employees and employers should understand.
What is vesting?
When it comes to retirement provision, vesting simply means ownership. In other words, each employee will transfer or own part or all of their account in the plan based on the plan’s exercise plan. All 401 (k) contributions that an employee makes to the plan, including pre-tax and / or Roth contributions made through deduction of wages, are 100% vested immediately. These contributions were money earned by the employee as compensation and therefore immediately and completely belong to the employee.
However, employer contributions to the plan are typically transferred on a plan-specific schedule (known as a vesting schedule), which may require the worker to work for a period of time in order to be fully vested or to “own” these funds. Ownership of employer contributions is often gradually established over several years. This can be an effective tool for employee retention by encouraging employees to stay long enough to receive 100% of their employer contributions.
What is a 401 (k) vesting schedule?
The 401 (k) Vesting Schedule is a set of rules that govern how much and when employees are entitled to (some or all) employer contributions paid to their accounts. The more years of service, the higher the vesting percentage.
Different types of 401 (k) vesting schedules
Employers have flexibility in determining the type and duration of the vesting schedule. The three types of exercise are:
- Immediate vesting – This is very easy since the employee is (or owns) 100% of the employer contributions immediately from the time of receipt. In this case, workers do not have to work for a certain number of years to claim ownership of the employer contribution. An employee who was hired at the beginning of the month and received an appropriate employer contribution in his 401 (k) account at the end of the month can leave the company the next day together with the total amount in his account (employee plus employer).
- Graded vesting schedule – Probably the most common schedule is gradual exercise. At least 20% of employer contributions must be vested after two years of service, and a 100% vesting period can be reached after two to six years to achieve a 100% vesting period. Popular tiered vesting schedules include:
|Graded 3 years||Graded 4 years||Graded 5 years||Graded 6 years|
|Years of service||% Free movement||% Free movement||% Free movement||% Free movement|
|0 – 1||33%||25%||20%||0%|
|1 – 2||66%||50%||40%||20%|
|4 – 5||100%||80%|
|5 – 6||100%|
- Cliff vesting schedule – With a Cliff Vesting Schedule, the entire employer contribution becomes 100% vested after a certain period of time. For example, if the company has a 3-year cliff vesting schedule and an employee leaves for a new job after two years, the employee can only pay the contributions to their 401 (k) account. You would not have ownership of employer contributions made on your behalf. The maximum number of years for a cliff plan is 3 years. Popular cliff vesting plans include:
|2 years cliff||3 years cliff|
|Years of service||% Free movement||% Free movement|
|0 – 1||0%||0%|
|1 – 2||100%||0%|
Frequently asked questions about vesting
What is a typical vesting schedule?
Vesting schedules can vary for each plan. However, the most common type of vesting schedule is the tiered schedule, in which employees gradually exercise a vesting period over time depending on the years of service required.
Can we change our plan’s vesting schedule in the future?
Yes, in a word of caution. To apply to all employees, the vesting schedule can only be changed to one that is the same or more generous than the existing vesting schedule. This is known as the anti-cutback rule and prevents plan sponsors from taking away services that the employees have already incurred. For example, if a plan has a 4 year vesting vesting schedule, it cannot be changed to a 5 or 6 year graded vesting schedule (unless the plan is ready to use separate vesting schedules for) Retain new hires from existing employees). With the same plan, however, the vesting schedule could be changed to a 3-year plan because the new benefit would be more generous than the previous one.
Since my plan does not currently offer employer contributions, I don’t have to worry about setting a vesting schedule, do I?
Regardless of whether your organization wants to make 401 (k) employer contributions or not, for maximum flexibility, we recommend that all plans include discretionary employer contribution provisions and a more restrictive vesting formula. The discretionary provision in no way obliges the employer to make contributions (the employer could decide each year whether and how much contributions should or should not be made). In addition, a restrictive vesting schedule means that the vesting schedule can easily be changed in the future.
When does a lock-up period begin?
Typically, a lock-up period begins with the hiring of an employee, so even if the 401 (k) plan is created years after an employee begins working in the company, all years of service before the plan was set up counted toward exercising. However, this is not always the case. The planning document may have been written so that the vesting period does not begin until the plan comes into effect. This means that if an employee was hired prior to creating a 401 (k) plan, the years of service prior to the plan’s entry into force will not be counted.
What are the methods of counting the service for exercise?
Service for vesting can be calculated in two ways: operating hours or elapsed time. Using the hours of service method, an employer can define 1,000 hours of service as a year of service, so that an employee can earn a vesting year of service in just five or six months (assuming 190 hours of work per month). The employer must carefully monitor the hours worked to ensure that the lock-up period is calculated correctly for each employee and to avoid that employer contributions are forfeited or redistributed.
The challenges of recording hours worked often lead to employers preferring the elapsed time method. This method calculates an exercise year based on the years from the employee’s hiring date. If an employee is still active 12 months after their hiring date, they will be credited with one year of non-vesting regardless of the hours or days worked in the company.
If there is an eligibility requirement to be part of the plan, does the vesting period begin after an employee becomes an authorized participant in the plan?
Usually no, but it depends on what was written in the planning document. As already mentioned, the vesting clock usually starts to tick when the employee is hired. An employee may not be able to participate in the plan because a separate authorization requirement has to be fulfilled (e.g. 6 months of service), but the calculation period for the authorization is completely separate from the blocking period. The only case in which an unauthorized participant cannot start exercising from his or her hiring date is when the planning document excludes the years of service of an employee who has not yet reached the age of 18.
How long does an employer have to deposit employer contributions to the 401 (k) plan?
This depends on how the planning document is written. If the planning document is written in such a way that employer contributions are to be made in each payment period, the plan sponsor must fulfill its fiduciary duty to ensure that the employer contribution is paid in time. If the planning document is written in such a way that the contribution can be made annually, the employer can wait until the end of the year (or even until the annual conformity check of the plan) until the contribution calculations are available from their provider.
What happens to an employer contribution that is not vested?
If an employee leaves the company before they are fully vested, the non-transferred portion (including the related income) expires and is returned to the employer’s plan cash account, which can be used to fund future employer contributions or to pay plan expenses. For example, if a 401 (k) plan has a tiered 6-year vesting schedule and an employee stops working after only 5 years, 80% of the employer contribution belongs to the employee and the remaining 20% will be returned to the employer if the Employee initiates a distribution of his account.
Note: We are not the author of this content. For the Authentic and complete version,
Check its Original Source