What are vesting schedules? They can turn your 'free' 401(k) match money into 'pretend' money if you don't know.

By Beth Pinsker

When you are new to a job, knowing when the company match belongs to you is as important as knowing how much it is

One of the biggest financial-literacy tenets for working adults is to contribute at least enough to your 401(k) plan to receive the full company match, because that is "free money." If you put in 3%, they put in 3%, and you've doubled your money.

Not so fast. There are usually some strings attached.

That company 401(k) match comes with what's called a vesting schedule, which is baked into the company's retirement plan. It lays out the rules for how and when employees will actually receive that match money, and - surprise - that's not always immediately. In fact, most companies use vesting schedules as a way to retain employees, so they often string them out as long as they think they can without turning off new workers - sometimes up to six years.

"Companies use it as a tool to solve a problem," says Jim Trujillo, a certified financial planner and principal at Cerity Partners who works with companies and their 401(k) plans. "If your problem is retaining talent, you may extend that vesting schedule more. More recently, what I've seen is companies fighting for talent, so some do shorter or no vesting to show they have a wonderful benefit."

The key thing for employees to know is that you don't have a choice in vesting schedules, and you can't negotiate for your own personal benefit. That vesting schedule will be set in the company's plan documents and has to apply equally to all employees.

There are a variety of vesting schedules, with the most generous being 100% vesting immediately. That means if you put in 3% and the company puts in 3%, you actually do double your money immediately.

Here are the other common options:

Graded vesting: You get a percentage of the match per year until you're fully vested. On a six-year schedule, for example, that could mean 0% the first year and 20% after each additional year of service. So if you put in 3% and the company allocates a 3% contribution but you leave your job in the first year, you would get none of that match. If you leave after the second year, you'd get 20% of the match. A four-year graded split, meanwhile, might be 25% each year. Each company chooses a plan as it wishes.

Cliff vesting: You get 100% of the match once you reach the cliff, which is typically after two or three years. So you get none of the match if you leave in the first year of employment, but after the second or third year, depending on the plan, you'd get 100%.

What happens to the leftovers?

If an employee leaves a company before their match is vested, the company keeps that money.

That money isn't exactly free to the company, because it has already allocated it, but the funds stay in its retirement account to help defray the administration costs of the plan. That means the company has to lay out less money to pay the match for other employees and therefore is essentially saving money. Large companies can have millions of dollars in forfeitures of unvested matches in their retirement funds. That aggregate in the U.S. amounted to $1.5 billion in 2022 from two million employees who left jobs, according to research by Samantha Prince at Penn State Dickinson Law.

Prince argues that this gives companies incentive to employ vesting schedules that are just longer than the tenure of their typical employee. So if a company usually retains workers for two years, it might make the vesting schedule carry over three years. Some companies she has tracked have also recently shifted from immediate vesting to graded vesting.

"People generally don't have money to afford putting it in retirement plans. That's why we need the company money to benefit the individual, and not the company itself," says Prince.

How to keep your free money

The best way to make sure you don't leave any free money on the table is to know what a company's vesting schedule is before you take a job - even while you are interviewing - so you can compare an offer to other options you may have. For instance, you may be looking at jobs at two big chain hardware stores, both of which are known for churning through employees quickly. One offers immediate vesting and one has a three-year cliff.

"If you don't understand the vesting, you might pick orange instead of blue, and you shouldn't," says Prince.

And before you leave a job, check to make sure you're fully vested. You might be months or even days away from claiming a significant amount of money. If you have the proper information, you can plan accordingly.

That being said, only a small percentage of prospective employees ask about a company's 401(k) match when they are interviewing or starting a new job, and an infinitesimal percentage ask about the vesting schedule.

"It comes down to just taking a couple of extra steps. Ask not just, is there a match, but what about vesting? Read just a couple more paragraphs of the enrollment book," says Trujillo.

If you're already working and are now curious about your company's vesting schedule, you can ask your human resources department. Or you can look for the plan documents through your employee portal or the online interface from the plan custodian. You may also be able to find them by searching online for the company's name and 401(k) plan documents. You're looking for the section on vesting of the company's match, not of the participant's contributions, which are always 100% vested.

Here's an example of a plan from a company with a two-year cliff: "Any amount credited to a Participant's Account, including Employer Credits, Transition Credits, Discretionary Credits and Earnings Credits on such amounts pursuant to Section 3.1 hereof, will fully (100%) vest upon the Participant's attainment of two (2) years of service (determined in the same manner as Vesting Service is determined under the COMPANY NAME Savings Plan)."

Some 401(k) custodians make vesting easy to track when you look at your account. You will see your employee contributions broken out from your employer contributions - routinely under a tab called something like "sources." Often, you will see listed the current vesting percent of the employee contribution. If you don't see something of this sort, you'll have to ask.

"We should have a better grasp of this, and we just don't. People don't even look at their retirement statements," Trujillo says.

One thing that helps, Trujillo says, is to meet one on one with an adviser your plan makes available. Trujillo has had many of those sessions with employees as part of his job, and he always starts by reviewing the account and looking at the current vested balance and reviewing when the employee will reach full vesting. That may be all they need to know to stick around a few extra months and not leave money on the table inadvertently.

"I think that's really the push people need," Trujillo says. "It's overwhelming, and that extra layer of talking helps."

April is National Financial Literacy Month. To mark the occasion, MarketWatch will publish a series of "Financial Fitness" articles to help readers improve their fiscal health, and offer advice on how to save, invest and spend their money wisely. Read more here.

-Beth Pinsker

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04-22-24 1057ET

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