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Vesting schedules
A 401(k) Plan (or 403(b) Plan will have a vesting schedule. Vesting schedules are usually based on the amount of time employees work for the organization.
Let's take a look:
Bernard started working for Company Q on January 1, 2024. He immediately signed up to participate in Company Q's 401(k) plan.
Company Q matches 100% of employee contributions up to 5%. However, Company Q's vesting schedule requires plan participants to be employed for 3 full years before assuming full ownership of company contributions.
That means that the money Bernard contributes to the plan is his. But he won't own Company Q's matching contributions until January 1, 2027.
As discussed in the ERISA section, employers must adopt 1 of 2 vesting schedules (at a minimum):
- 3-year cliff vesting: 0% vested for less than 3 years of service; 100% vested after 3 years.
- 6-year graded vesting: the employee is 20% vested after the 2nd year of service with 20% increases each subsequent year until the employee is fully vested at the end of the 6th year of employment.
Employers can always adopt a more liberal vesting schedule than the statutory requirement, such as immediate vesting.
If an organization automatically enrolls its employees in a 401(k) plan and the plan requires employer contributions, employees vest in those contributions after 2 years.
Employee investments
Choosing where to invest money is tough for anyone. And it may be the most difficult decision your participating employees will tackle. But you can make it easier for them.
Give your employees plenty of investment choices. As always, you'll have to consider the needs of ALL of your employees. Choices should range in risk to satisfy employees of all ages. For those who don’t want to make decisions about how to allocate their deferrals, there should be funds that do that for them with risk based on time to retirement. Some 401(k) plans also offer an AI assistant to help enrollees with their decisions. And don't forget to give your employees ample opportunity to revise their investment choices. Revision opportunities should be offered to employees several times each year.
Withdrawals
Employees are usually penalized for making defined contribution plan withdrawals prior to age 59½. However, you can set up a plan that lets participating employees tap into their retirement accounts for specific reasons.
Special reasons may include:
- obtaining a loan to purchase a home
- getting a loan for educational purposes
- hardship withdrawals
But the implementation of this option will cost your company a fee. And the employee should think twice about borrowing from their retirement savings, since they will be taxed three times on the amount borrowed:
- once when the money is taken out of the 401(k)
- again, when the 401(k) is repaid with after-tax dollars
- a third time when the money is taken out at retirement
Make sure you take that into consideration when installing your defined contribution retirement plan.
Many 401(k) topics can be found on the IRS website: www.irs.gov.
Memory Jogger
Your company does not allow early withdrawals from 401(k) plans. At what age can employees begin to take money out without penalty?