Vesting Rules Determine How Much of Your Retirement Account You Own

By David J. Kupstas, FSA, EA, MSEA

David J. Kupstas, FSA, EA, MSEA

David J. Kupstas, FSA, EA, MSEA Chief Actuary

In qualified retirement plans, vesting refers to what portion of your benefit you get to take with you when you receive a payout from the plan. It’s how much of your account you “own.” If you are 100 percent vested, it means you are entitled to receive your entire account balance upon distribution. 

If you are zero percent vested, you would not be entitled to receive any of your account balance upon leaving the company. Instead, your account would be forfeited. The money would stay in the plan and be moved to the accounts of other employees or be used to pay administrative fees. You can be partially vested, say 40 percent or 60 percent, in which case you could receive part of your account as a distribution, while the rest of your account was forfeited.

Common Vesting Schedules 

Your vested percentage is determined by your plan’s vesting schedule. The vesting schedule is based on your years of service. One common vesting schedule is the “six-year graded” schedule: 

0-1 years of service

0% vested

2 years of service

20% vested

3 years of service

40% vested

4 years of service

60% vested

5 years of service

80% vested

6 or more years of service

100% vested








Another common vesting schedule is the “three-year cliff” schedule: 

0-2 years of service

0% vested

3 or more years of service

100% vested




A plan may use a different vesting schedule so long as it is at least as generous as one of these two schedules at every level of service. Thus, a two-year cliff schedule would be permitted, as would a five-year graded, as would a schedule that starts out looking like the six-year graded schedule but then provides full vesting at four years of service. Each of these alternative schedules has a vested percentage that is at least as high as the six-year graded or three-year cliff schedule at every level of service. 

In the olden days, 10-year cliff and 15-year graded vesting schedules were permitted. Over the years, the vesting rules have been tightened so that the six-year graded or three-year cliff schedules are about the longest you can keep people from full vesting. A traditional defined benefit plan still allows a seven-year graded or five-year cliff schedule, unless the plan is top-heavy, in which case vesting must follow at a minimum the six-year graded or three-year cliff schedule. 

A cash balance plan must provide for full vesting after three years of service. 

Determining Vesting Service 

A “year of service” as it relates to a vesting schedule is somewhat of a misnomer. For vesting purposes, a year of service is usually defined as the completion of 1,000 hours of service in a single plan year. For an employee working 40-plus hours a week, it takes six months or less to attain 1,000 hours of service. Thus, it is possible for an employee hired on July 1, 2018 to attain three years of vesting service by June 30, 2020. A vesting year would be credited for each of 2018, 2019, and 2020 – three years of vesting service, but only two years as the calendar flies. If the vesting schedule was three-year cliff, this would be good enough to get that employee to 100 percent vesting. 

Vesting doesn’t have to be based on the plan year, which is usually the calendar year. You can measure years of vesting service based on hours of service worked from the hire date to the hire date anniversary, and thereafter from hire date anniversary to the next hire date anniversary. Plans we work on do not usually operate this way, as it is difficult to tie together the hours worked in 12-month periods that span over two separate plan years. 

Years of service don’t necessarily have to be based on hours of service. Under the elapsed time method, you simply count the time based on the calendar. The employee hired on July 1, 2018 would attain three years of service on June 30, 2021. The elapsed time method eliminates the need to count hours and prevents odd situations like the one where it takes only two years to attain three years of service. However, due to other wrinkles and oddities, the elapsed time method is seldom used in our plans. 

It is possible for an employee to work at a company for a long time but not ever attain full vesting if he doesn’t complete enough hours of service. Under normal vesting rules, someone who works 20 years at 500 hours of service per year will never have a year of service for vesting and therefore will always be zero percent vested (unless and until he attains normal retirement age at the company). 

Sometimes Full Vesting Occurs Automatically 

Certain contributions may not be subject to a vesting schedule and must be 100 percent vested at all times. Salary deferrals in a 401(k) plan must always be 100 percent vested. It would be bad public policy to have someone contribute to a plan from his own paycheck and then forfeit that money if he didn’t work enough years of service. Fewer employees would probably choose to contribute under those circumstances. 

Other contributions and benefits which must always be 100 percent vested include 

  • Safe harbor matching or nonelective contributions
  • Qualified nonelective contributions (QNECs) and qualified matching contributions (QMACs)
  • Rollovers from other plans 

When an employee reaches normal retirement age, he must become 100 percent vested. Normal retirement age is usually 65. A plan may specify that normal retirement age will not occur until a minimum number of years elapses since plan entry. You may see normal retirement age expressed as something like “the later of age 65 or the fifth anniversary of plan participation.” 

If a plan terminates entirely, all benefits automatically become 100 percent vested. When there is a partial plan termination, the affected participants are automatically 100 percent vested. A partial plan termination occurs when a significant number of employees lose their jobs because of a single event, such as a plant shutdown, or a series of related events. 

A Vesting Example 

Here is an example to illustrate the points made so far. Consider a 401(k) plan that includes salary deferrals, safe harbor nonelective contributions, and profit sharing contributions. The vesting schedule is six-year graded. Jenna has completed three years of service and is therefore 40 percent vested. Her vesting situation may be illustrated as follows: 

Money Type

Account Balance


Vested Account Balance

Salary Deferral


100% automatically


Safe Harbor


100% automatically


Profit Sharing


40% per schedule







Should Jenna leave the company and receive a distribution of her account balance, she would be entitled to $146,000 and not the full $170,000 because she is only 40 percent vested in her profit sharing account. The other two money types are always 100 percent vested, so Jenna would receive those full amounts. The $24,000 from the profit sharing account that is not vested would be forfeited and reallocated to other employees or used to pay fees. 

Other Vesting Notes 

An employee must generally receive credit for vesting service even for years worked before becoming eligible for the plan. A plan may exclude years of service completed before age 18 or before the plan’s effective date, assuming there is no predecessor plan. 

An employer may decide to amend the vesting schedule in its plan. If it does, any participant with at least three years of service may choose to remain on the old vesting schedule if it is more advantageous to do so. 

If an employee is switched to a less favorable vesting schedule, his vested percentage will remain where it is until it starts increasing again under the new, lesser schedule. The vested percentage will not drop even if the new schedule has a lower percentage for the number of years of service the employee had at the time of the switch. 

Short plan years present an interesting situation. A short plan year occurs when there is a change in plan year. If a plan changes from an October 1 to September 30 plan year to a calendar plan year, there will be a short plan year from October 1 to December 31 to get the years on track. 

If the change in plan year is made in 2018, the vesting computation periods will look like the following: 

  • October 1, 2017 through September 30, 2018
  • October 1, 2018 through September 30, 2019
  • January 1, 2019 through December 31, 2019

The employee will be granted a year of service for any of those periods during which he completes 1,000 hours of service. Note that the hours of service worked between January 1, 2019 and September 30, 2019 are counted twice. Contrary to popular belief, there would not be a short vesting year from October 1, 2018 through December 31, 2018 even though there is a short plan year of that duration.

Talk to a Retirement Plan Expert Today

— Topics: Retirement