401(k) Vesting: Not All of the Money in Your 401(k) Is Really Yours

Now, more than ever, investing is an important part of retirement planning. And one of your investment options as an employee might be a 401(k) plan.

Participating employers offer 401(k)s for employee retirement investment plans. Over time, the money you contribute — combined with your employer’s contributions — can build your retirement nest egg. When your company participates in a vesting schedule, however, you can’t claim all of those 401(k) investment funds until you’ve been employed for a certain amount of time. Keep reading for everything you need to know about vesting schedules for your 401(k) investments.

What Is Vesting?

Vesting refers to 100% ownership of all the funds in your 401(k) plan, meaning that an employer cannot take it back for any reason. So, 401(k) vesting represents how much of the employer-contributed funds that you own in any given year.

How Does 401(k) Vesting Work?

When you participate in a 401(k) plan, you and your employer contribute a prearranged sum of money to your account each pay period. The money you contribute to your 401(k) is always 100% yours but you must be fully vested to claim all of the money your employer contributes. Vesting typically takes three to five years depending on your company’s plan.

Fully vested, by definition, means that you own all the funds in your account. During the time period that it takes to become fully vested, you can be partially vested. Being partially vested means that you don’t own all of the funds your employer has contributed but you might own a certain portion depending on how long you’ve worked for your employer and its vesting schedule.

Are You Retirement Ready?

What Are Vesting Schedules?

Companies maintain 401(k) vesting schedules to encourage employees to stay with the company. Guidelines for vesting are federally regulated, but employers can choose from different schedules. Here are the available vesting schedules:

Cliff vesting: No vesting for a period of time, followed by immediate 100% vesting after no more than three years of service.

Graded vesting: This is also known as gradual vesting, such as none the first year and 20% in the second, third, fourth, fifth and sixth years each to reach fully vested status at the end of the sixth year. An employer can change the actual timelines and percentages as long as the change benefits employees.

For example, a company might participate in cliff vesting and fully vest employees after three, rather than six years of service.

Many employers use the six-year graded method, which partially vests employees until they’ve served six years, at which time they become fully invested. Plans vary among employers, however. Check with your plan administrator to find out about the specific details of your 401(k) plan.

FAQs About 401(k) Investing

Like any investment, 401(k) plans have pros and cons. Here are some frequently asked questions about 401(k) plans:

1. Am I eligible to join a 401(k) plan?

Typically, you must be at least 21 and have worked for a company for a year to participate in a 401(k) plan.

2. Is all the money in my 401(k) actually mine?

For all of the funds to be yours, you must be fully vested. Whether or not you are fully vested depends on whether you’ve met the 401(k) vesting rules specific to your employer’s 401(k) plan. If you’re not yet fully vested, your 401(k) balance might not be an accurate reflection of what money is actually yours. Your balance might show the amount of a fully vested employer contribution, only to have your balance adjusted to reflect your vested amount when you leave your job or roll over your plan.

Are You Retirement Ready?

3. What if I want to withdraw money from my 401(k) before I retire?

Depending on your employer’s plan, once you’re fully vested, you might be eligible to borrow up to 50% of your vested funds. Generally, you’ll repay the funds — plus interest payments — via payroll deductions. However, the funds must be paid back within five years. Also, if you decide to leave your employer before the loan is paid off, you will likely have to pay the balance immediately and in full.

4. What happens to my 401(k) when I quit my job?

You might take your 401(k) investment account with you when you leave your job or you might decide to leave it with your former employer. Here are your options:

  • Leave your investment with your former employer: If your new employer doesn’t offer a 401(k) plan, it might make sense to leave yours with your former employer. Keep in mind, however, that you won’t be able to borrow from or make additional contributions to the plan. However, you may be able to still make changes to your investments.
  • Withdraw the funds: If you’re 59.5 or older and you quit your job, you can withdraw your funds in a lump sum, which will be subject to income tax. If you quit your job and withdraw your funds before you’re 59.5, however, you’ll also be subject to having a 10% penalty tacked on to the income tax you’ll owe on the money.
  • Transfer the funds to your new employer’s plan: Your employer might allow you to transfer your 401(k) funds to its 401(k) plan — and you might not have to pay taxes or penalties.
  • Roll your 401(k) into an IRA: If your new employer doesn’t offer a 401(k) or doesn’t offer the investment options you prefer, you can convert your 401(k) into a Roth or traditional IRA. Depending on what type of IRA you choose, you might be subject to paying taxes or other fees.

Be Informed Before Making Decisions About Your 401(k)

Although a 401(k) plan can be a good retirement vehicle, not all plans are the same. Always check with your company’s benefits administrator to make sure you understand your plan’s rules — and how they will affect your retirement account.

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