As you become more familiar with your 401(k) plan you’ll notice the term “vesting” is written throughout your various plan documents. Let’s briefly cover what this is and what it means for you.
Being “vested” is different from being “invested”. The word comes from the Latin word vestire which literally means “clothed with a loose outer garment”. In today’s parlance, we say “vested” to mean “it’s yours”. If you’ve ever been to a wedding you’ve heard the officiant say “by the powers vested in me” – literally meaning the powers that he now has. He went through ordination and earned the right to marry people.
In your 401(k) you may have money in your account which you have to “vest” into in order to keep it. Now, before we go any further let’s remember that money can come into your account from two different directions: from you or from your employer. Let’s talk about how vesting applies to each:
Where does vesting apply:
The money that you save into the 401(k) account is always yours; it’s always vested. You don’t ever have to earn your way into keeping your own money. So, when you see your account balance, everything that you’ve contributed will be immediately vested.
The money that your employer contributes to your account might need to be vested. Depending on the rules associated with your particular 401(k) plan, employer contributions can either be immediately vested (100% yours, right away) or subject to a vesting schedule.
Sometimes it’s both: if your employer offers a “Safe Harbor” 401(k) plan than any “matching” contributions they put in your account are immediately vested. Beyond that – some employers, from time to time, will put a different type of contribution into your account called a “Profit Share”. These profit-sharing contributions are above and beyond the match and are almost always subject to a vesting schedule.
So, what does vesting mean to me?
In your 401(k), vesting means that you’ll earn a specified percentage of the money in the account after a set amount of time.
Obviously it will be important to understand your company’s vesting rules. A company can use a cliff or a graded schedule for retirement plans. This means that the contributions from the employer are 100% available after a certain number of years (cliff) or a percentage of it is available each year (graded).
If your company uses cliff vesting, you won’t be vested in any portion of the benefit until you hit the cliff date. Once you hit that date, you’re 100% vested in that particular benefit.
In a graded vesting schedule you are vesting a portion of the benefit each year. For example, you may vest into 20% after year one, 40% after year two and so on.
If you have money in your account that you’re not vested in, you will lose those funds if you change employment or decide to withdraw. Also, regardless of whether your money is partially or fully vested, it still follows the same restrictions and penalties if withdrawn prior to retirement (see our previous article).
If you have any concerns or questions around what the schedule is for vesting, your HR department, 401(k) plan sponsor or a Invst advisor will be able to help.
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