If an employer matches 401k contributions, does each match have its own vesting schedule?

Question

Consider the following example where an employer matches 50% of your 401k contributions, and there is a 5 year vesting schedule on the match.

           Your contribution     Employer match
Year 1           $10K                  $5K
Year 2           $10K                  $5K
Year 3           $10K                  $5K
Year 4           $10K                  $5K
Year 5           $10K                  $5K

So after 5 years, your 401K account has $75K in it ($50K from your contributions and $25K from employer matching).

Let's say you leave the company after Year 6. How much of the employer's $25K in matching do you get to keep?

I was always under the impression that you would only get to keep $15K ($5K + $4K + $3K + $2K + $1K) in that scenario. Because after Year 6, 100% of the Year 1 matching had vested, 80% of the Year 2 matching had vested, 60% of the Year 3 matching had vested, 40% of the Year 4 matching had vested, and 20% of the Year 5 matching had vested.

(Edit: The reason I thought that was because at every single company where I have received either a stock option grant or RSU grant, the accompanying vesting schedule was based off the date of the grant, not the date that I started employment. I thought the 401K matching would work the same way.)

But my coworker insists that you would get to keep all $25K in that scenario. He thinks that there is only one vesting schedule that starts when you begin the 401k, and it applies to all current and future employer matches. Is that the case?

Answer 1

In the early days of 401Ks (think 1980's) the vesting schedules were not as regulated - so it is possible that some company had that complex a vesting schedule. The purpose of a vesting schedule is to reward employees who stay at least until they reach 100% vesting.

Here are some IRS documents discussing vesting:

“Vesting” in a retirement plan means ownership. This means that each employee will vest, or own, a certain percentage of their account in the plan each year. An employee who is 100% vested in his or her account balance owns 100% of it and the employer cannot forfeit, or take it back, for any reason. Amounts that are not vested may be forfeited by employees when they are paid their account balance (for example, when the employee terminates employment) or when they don’t work more than 500 hours in a year for five years.

and vesting as it relates to 401K qualification:

Minimum vesting standard must be met.

A 401(k) plan must satisfy certain requirements regarding when benefits vest. To “vest” means to acquire ownership. The vested percentage is the participant’s percentage of ownership in his or her account. All participants must be fully (100%) vested in their 401(k) elective deferrals. A traditional 401(k) plan may require completion of a specific number of years of service for vesting in employer discretionary or matching contributions. For example, a plan may require 2 years of service for a 20% vested interest in employer contributions and additional years of service for increases in the vested percentage. Matching contributions must vest at least as rapidly as a 6-year graded vesting schedule. A safe harbor and SIMPLE 401(k) plan must provide for 100% vesting in employer and employee contributions at all times.

This means that the vesting can take no more than 6 years. Also there are limits regarding how to count years of service. It doesn't seem to mater if the employee started on day one, or if they waited a few years. They will reach 100% vesting on the same date either way based on how the employer setup the program.

Answer 2

I've never heard of a vesting schedule which you describe. Your co-worker is right: it (technically, a graded schedule) starts from date of employment (which includes situations where you're eligible for matching a year after your date of employment).

Of course, to be sure, read your 401(k) plan documents. That'll tell you everything you need to know.

Answer 3

Any 401k plan that I've been in, the vesting schedule goes by the date you started work at that company. Like my last job said you were 20% vested after 1 year, 40% at 2 years, 60% at 3, 80% at 4, and 100% at 5. That percentage applies to ALL matching contributions. So it's not like each contribution gets an increasing vesting percentage as that contribution ages, but that the percentage applies to all contributions.

So assuming your employer match was $5,000 per year and vesting increased at 20% per year like my last job:

      Match     Total           Vested
Year  for Year  Match  Vesting  Amount
----  --------  -----  -------  ------
1     $5k       $5k    20%      $1k
2     $5k       $10k   40%      $4k
3     $5k       $15k   60%      $9k
4     $5k       $20k   80%      $16k
5     $5k       $25k   100%     $25k
6     $5k       $30k   100%     $30k

etc

I can't swear that all vesting schedules work like this. I don't know exactly what laws or regulations exist about it. But this is how it's worked at every company where I've had a 401k

Additional Thought

This omits the fact that, one would hope, your investments are making a profit. So hopefully after the employer has contributed $15k, you don't have $15k in your account, but something more than that. The way it's worked at jobs I've had is that profits on investments are allocated between the employee contribution and the employer contribution. Like if as of some date the employee has contributed $20k and the employer has contributed $10k, total investment $30k, and the account is now worth $33k, that they'd say okay that's a 10% profit, so $2k of that is on the employee contribution and 1k$ is on the employer match. Then the vesting schedule applies to the employer match, you are always 100% vested in your own contribution and the profits on it. In real life the allocation formula is more complicated than that, because you may have investments in multiple funds giving different returns, the rate of contributions may have varied over time, etc.