Definition and Example of Partial Vesting
Partial vesting is the process by which employees become fully entitled under an employer-sponsored retirement plan after a certain number of years. When one is vested in their retirement plan, it means they own the assets in their account. Partial vesting allows employees to attain 100% ownership of their retirement accounts according to a schedule defined by the plan’s terms.
How Partial Vesting Works
Partial vesting operates by setting a specific timeline for gaining full ownership rights in an employer-sponsored retirement plan. According to IRS rules, defined contribution plans such as 401(k) or 403(b) may have maximum partial vesting periods of three years. In a defined benefit plan or pension plan, the maximum partial vesting period can be five years.
During the first year, your vesting percentage will be 0% in the plan, provided the employer opts to make matching contributions. Your vesting percentage will also be 0% in the second year. After the third year, you will be 100% vested in the plan.
Your plan may specify certain guidelines regarding what constitutes a year of service, although this is generally defined as 1,000 hours of work over a 12-month period, according to the IRS.
This type of vesting differs from immediate vesting or graded vesting. With immediate vesting, employees own 100% of employer matching contributions as soon as those contributions are made to their accounts. Graded vesting spreads out the vesting gradually, with employees becoming increasingly vested each year until they reach 100%.
Partial Vesting vs. Graded Vesting
Employers can structure workplace retirement plans to follow either a partial vesting schedule or a graded vesting schedule. Immediate vesting is also an option, although this is less common. With graded vesting, the employee’s ownership percentage increases gradually year by year until it reaches 100%.
Suppose you accept a job with an employer that follows a graded vesting schedule over six years. Here’s how your account ownership could look:
Years of Service – Vesting Percentage
1 – 0%
2 – 20%
3 – 40%
4 – 60%
5 – 80%
6 – 100%
7 and beyond – 100%
Partial vesting and graded vesting provide entirely different pathways to acquiring 100% of the employer matching contributions in a 401(k) or similar defined contribution plan. With partial vesting, one can be fully vested at a faster pace, whereas graded vesting can take up to twice as long. Conversely, if you decide to leave your employer before the third year, you may still take some of the matching contributions with a graded vesting schedule instead of partial vesting.
If you leave your job or are terminated before the third year in a partial vesting plan, you will only retain the money you contributed and your earnings.
Key Takeaways
Partial vesting allows employees to become fully entitled in defined contribution plans within three years. Graded vesting may extend up to six years instead, although it can permit employees who leave their jobs early to take some matching contributions with them. For employees planning to complete at least three years of service before changing jobs, partial vesting provides an advantage—but such plans can be costly for companies facing high turnover rates. All contributions in SEP or SIMPLE IRA plans must be 100% vested according to IRS rules.
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Sources:
IRS. “Retirement Topics – Vesting.” Accessed December 21, 2021.
IRS. “Employee Benefits Plan: Interpretation No. 2 – Minimum Vesting Standards for Defined Contribution Plans,” page 10. Accessed December 21, 2021.
U.S. Department of Labor. “Questions and Answers on Retirement Plans and ERISA,” page 4. Accessed December 21, 2021.
Source: https://www.thebalancemoney.com/cliff-vesting-5214054
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