Back in 1996, my banking job was moved 100 miles from where I worked. I was offered a choice of moving or leaving. As I did the calculations (1,000 miles of driving per week, oil change every three weeks, no salary increase, family to support), it became pretty clear that I needed to look for a new job. As I ruminated on this, I overheard my colleague, Lorena Lopez telling the department head that she would stay on and continue to help but he had to promise to keep her through her six-year anniversary so she would be fully vested. Say what?
And that was my introduction to 401k vesting schedules. A 401(k) vesting schedule is a plan that determines when an employee can fully own their employer's contributions to their 401(k). Vesting schedules are used to encourage employees to stay with a company longer.
Vesting schedules come in a variety of flavors.
Immediate vesting: The employee immediately owns 100% of their employer's contributions.
Cliff vesting: The employee doesn't own any of their employer's contributions until a specific period of time has passed.
Graded vesting: The employee gradually owns more of their employer's contributions over time. This was the case with the bank Lorena and I worked at. Matching contributions from the bank vested over a six year period which is the longest period of time allowed under current regulations.
If an employee leaves before fully vesting, they may forfeit some or all of their employer's contributions. An employee is fully vested when they own 100% of their 401(k), including any employer contributions. This can happen after a certain number of years of service, or when the employee retires or the company terminates the plan.
The idea behind vesting is that it benefits both the employee and the employer. It rewards employees for their loyalty, and reduces the risk of losing money if an employee leaves early.
It was against this backdrop that I perused the latest report from Vanguard on this very topic. Employer contributions are important to building wealth yet over 50% of the plans Vanguard surveyed had vesting schedules. Vanguard's research indicates that the vesting does not provide a systematic retention benefit
The impact of vesting in employees is tremendous. "Forfeitures occur in 30% of job separations, are most common among lower-income participants, and represent 40%, on average, of the affected participants’ final account balances." Not surprisingly, vesting forfeitures impact high-turnover industries the most and in particular are disadvantageous to minority and low-income workers.
As I look back on 35 years in the industry, 19 years running my practice, and advising over 100 retirement plans. I get where the vesting schedule is coming from. My feeling though is that if an employee wants to leave for greener pastures, they will do just that. As one of my CEOs told me, "I don't believe in vesting. The whole reason I can pay a match is because of my employees. They earned the match. It is theirs with no strings".
A further complication is that employees may not be aware of the vesting. To test this idea, Vanguard asked employees who had left a company/ taken their money whether they knew the 401k vesting schedule. Only 33% knew it.
The Parting Glass
Vanguard's study looked at 1,500+ retirement plans and 4.7 million termination withdrawals to reach its conclusions. For a short six-page report, it is packed with data. I am not a fan of vesting schedules as it seems to be questioning an employee's loyalty. Administering the vesting schedule is also time-consuming for employers. And given how frequently employees these days jump jobs, vesting can be harmful to the idea of "retire with dignity". Perhaps it is better to tighten up interviewing on the front end to get the best-fit employees for a company?