Vesting: The Achilles Heal of 401(k) Plans

February 7, 2014

401kEmployer matching contributions are one of the biggest benefits of 401(k) plans. You put money in out of your own paycheck to fund the plan, and your employer offers at least a partial match. The catch is that the employer match usually comes with a vesting provision. That’s a period of time – up to five years – which must pass before matching contribution are considered a permanent part of your plan. In this way, vesting may also be the Achilles heal of 401(k) plans. They don’t always pan out.

That may not be a pleasant thought to consider, but it is an unfortunate reality.

You May Never Be Around Long Enough to Be Vested

Employer matching contributions have been around since 401(k) plans were rolled out back in the 1970s. But back then job security was also a common feature of employment. You could start with an employer when you were in your 20s or 30s, and be reasonably certain of a career of 30 years or more at the same place.

Today’s employment landscape is much different – in fact, it’s a bit of a crapshoot. While there is still the possibility that you can spend 10, 20, or 30 years with the same employer, it’s at least as likely that you will only be there for a year or two.

If your employer’s matching contribution requires five years for full vesting, but you only work with the company for three years, the match may be completely worthless. You will lose it as soon as you leave your job.

Many companies offer a generous employer match on the 401(k) as an incentive to draw talented workers to them. And many employees are drawn to just such an arrangement. But if the vesting period is longer than the typical job at the company lasts, the employer match is more an illusion than a reality.

Don’t Count on the Company Match

The moral of the story: Don’t count on the company 401(k) match, no matter how good it may not be. One frightening reality is that some employers are revolving doors – employees come and go – either because they are fired or because they quit. The employer may be offering a generous match specifically to overcome employee resistance to joining the company. But if turnover is high, and the employer match rarely sticks, the incentive will be cost-free to the employer – and a complete bust for the employee.

When making your retirement plans, don’t count on your company match – at least not until you have satisfied the vesting period and the employer 401(k) match is a reality.

In the meantime, plan your retirement as if there is no company match. There are various ways that you can do this.

Make the Largest Contributions

Time is money when it comes to investing for retirement, which is why it’s critical that you maximize funding into your plan in the early years. Make the largest employee contribution that your plan allows.

Don’t figure the employer match in your contributions. For example, if your plan allows you to contribution up to 15% of your pay, make sure that you’re contributing the percentage. Some employees play with these numbers. For example, if the company gives a 50% matching contribution up to the first 10% contributed by the employee – effectively a 5% match – the employee may reason that they are contributing 15% of their pay by virtue of the fact that 10% is coming from them, plus another 5% from the employer.

But if the employer match fails for any reason, your net contributions – after the fact – will go back to nothing more than 10%. This is why you need to contribute as much as you are able, and consider the employer match to be a bonus.

Have an IRA or Roth IRA

This also makes an excellent case for having supplemental retirement plans, particularly an IRA – Traditional or Roth. By having an IRA, you’re not completely dependent upon the employer plan or the promised match. You’ll be accumulating money to both your 401(k) and your IRA, so that if the match doesn’t pan out you’ll be better off than if you had relied completely on the company plan.

An IRA is worth having even if it isn’t tax-deductible. The earnings in the account will accumulate on a tax-deferred basis, even if your contributions aren’t deductible. And when you do reach retirement age, the contributions that you made can be withdrawn without being subject to income tax. That by itself is a benefit everyone should have.

Have Non-Retirement Savings Too

Unfortunately, for many people their only savings account of any kind is the employer 401(k) plan. Now if you had to pick one single savings vehicle to have, the 401(k) plan is an excellent choice. But that also means that you’re completely dependent upon the company plan, not only for your retirement but also for your total entire savings strategy. That’s never a situation than anyone should put themselves into willingly.

Saving money outside of retirement plans is always important, but it’s even more important for any reason you cannot have an IRA account as well. And like an IRA, the savings that you accumulate in your non-retirement savings can offset an employer matching contribution on your 401(k) that never materializes.

How much have you benefited from the employer 401(k) match, either in your current job or in previous positions? Leave a comment!

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Kevin

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Kevin
Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.

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4 Responses to Vesting: The Achilles Heal of 401(k) Plans

  • Mel @ brokeGIRLrich

    I definitely agree with this article. I recently left a particularly rough job, with a very high turnover rate, at the end of last year after just over 1 year with them. I was only 20% vested at that time. I even had to fight myself to get through the last few weeks to hit a year to make the 20% vested mark.

    I think things like vesting are just something potential employees need to remember to ask about. It does provide a good bridge into asking how long the last few people in your potential position remained with the company.

    • Kevin Mercadante

      Hi Mel – While I don’t think that every employer who offers a company match is a revolving door, it is something to watch out for. The match you’re counting on could vaporize if you leave early. And some employers do foster that outcome. I’ve been with a couple myself – staying isn’t an option.

  • Roger @ The Chicago Financial Planner

    Nice post Kevin. Many 401(k) participants forget about the vesting issue as it pertains to the employer match. Many plans have gradual vesting, a typical schedule might be an equal portion of the match becomes vested over 4 or 5 years. Cliff vesting, where vesting is all at once cannot be any longer then 3 years under the Pension Protection Act of 2006. If a plan is Safe Harbor then within the safe harbor limits (80% of the first 5% matched or 3% given to all participants) the employee is 100% vested in the match from day 1.

    I agree this is an important issue for participants to consider.

    Looking at it from the employer’s viewpoint, the purpose of offering a 401(k) should be to attract and retain good employees. Turnover of good employees is costly so if vesting is a way to make good employees think twice about leaving then so be it.

    • Kevin Mercadante

      Hi Roger – I think that for many employees, vesting doesn’t become an issue unless they leave the employer before they’re fully vested in the employer match. They may know it when they start with the company, but under the assumption that they’ll be with the employer “forever” they may forget about the limitation.

      And I completely agree, from an employer standpoint, the match should be to attract the best talent.

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