As defined by the IRS, vesting in a retirement plan means ownership. Each employee vests a certain percentage of their account in the 401(k) plan every year. An employee who becomes 100% vested in his or her 401(k) account balance owns 100% of the balance. When this occurs, the employer cannot take it back (forfeit) for any reason.
Amounts that are not vested in a 401(k) may be forfeited by employees when they are paid their balance (as when the employee terminates) or when they have not worked more than 500 hours in a year for five years. An employee’s contributions to the plan (elective tax-deferrals deducted from the employee’s salary) are always 100% vested.
A variety of vesting schedules, as determined by the plan document, can apply to employer 401(k) contributions. These schedules can range from immediate vesting to 100% vesting after three years of service to an employee’s vested percentage that increases with each year of service to the employer. “Years of service” for purposes of vesting is defined by the plan. Generally, a year of service is 1,000 hours worked over 12 months.
As stated by the IRS, all employees must be 100% vested in their 401(k) accounts by the time they reach normal retirement age under the plan. All employees must also be 100% vested when the plan is terminated. This means that employer matching and profit-sharing contributions must be fully vested at these times, regardless of the vesting schedule stated in the plan document.
Any contributions to the plan that are deducted from your paycheck are always 100% vested. However, matching funds from the company usually vest over time. Although it can vary from plan to plan, matching funds from employers typically vest at 25% or 33% a year, or all at one time after three or four years.
Generally, it takes approximately three to five years for employees to become 100% vested in their 401(k)s, at which point they own all their employer’s matching contributions. If you leave your job before that point, even if you are laid off, you will lose the portion of your employer’s contributions that is not yet vested. Our knowledgeable agent will be happy to review your 401(k) plan and help you determine when you will become 100% vested and what percentage of your employer’s contributions you currently own.
Employee 401(k) contributions are tax-deferred, so it makes sense to contribute as much to your 401(k) as you can. The more you contribute, the less income tax you will need to pay on the year’s earnings. However, there are annual limits to how much you can contribute. In November of 2018, the IRS announced an increase in the annual contribution limit for 401(k)s from $18,500 to $19,000 for 2019. If you are age 50 or older, you are allowed to make additional catch-up contributions of up to $6,000 per year.