Your employer distributed an email this week stating that some updates have been made to the employee benefits package. As you peruse the document you come across a table labeled, ‘Vesting Schedule’, next to information about your 401k retirement plan.
It has ‘Years of Service’ on one column and ‘Vested Percentage’ on the other, and it might look something like the table below.
Admittedly, you had never done much homework on understanding your plan to begin with, and you take this as an opportunity to self-educate.
Breaking it Down
You already possess a basic understanding of the concept of 401k ‘matching’, where an employer matches an employee’s contribution dollar for dollar up to a certain percentage of the salary. You come to learn that this number is 6% in your case.
If your salary is $40,000, that means your employer will match every dollar you put in your 401k, up to $2,400.
.06 x 40,000 = 2,400
Over the course of the year you successfully stash $2400 in your 401k and, voila, at the end of the plan year the employer deposits $2,400 directly to your account! Pretty sweet!
You also notice that on your plan’s website the ‘Overall Balance’ is higher than the ‘Vested Balance’.
Why is that? What does ‘vested’ mean, exactly?
In the simplest of terms, vested means ownership…and until you are fully vested, you don’t yet have complete ownership.
Looking back at the Vesting Schedule above, you notice that with each year of service (called graded vesting), the percentage of your vesting- or, ownership- is going up. You’ll also notice that you don’t have any ownership until you have completed at least 1 year with the company, at which point, you are entitled to 20% of the funds your employer has contributed to your account. And with each subsequent year, you gain an additional 20% until you reach 100% (fully vested) at 5 years of service.
Note: You are always entitled to the funds that you contribute. The numbers indicate your level of entitlement to funds that your employer has contributed.
Therefore, at the end of your first year of service, you are entitled to 20% of the $2,400.
That comes out to $480.
.20 x 2,400 = 480.
If you were to take a job with a new company halfway into your 2nd year of employment, you are entitled to $480 of the $2,400 from your employer.
Or, perhaps you end up staying with the company and you reach your 2-year anniversary. You are now entitled to 40% of employer-deposited funds and, because of a small salary increase (2.5%; salary is now $41k/year) at the 1-year mark, your contributions (and thus your employer’s contributions) rose to $2,460 by the end of your 2nd year.
Now, pay close attention to the jump that occurred at Year 2.
Your ownership jumped from $480 to $1,944! At Year 1 you were only entitled to 20% of the employer contributions for that first year, whereas at Year 2, you became entitled to 40% of all employer contributions to-date! You can anticipate how that number can continue to climb, as both the vesting percentage and the total amount of what your employer has contributed, increase…
Understanding how these simple figures work can prove highly beneficial when studying your benefits package. Every little bit adds up, and compounded over time, small numbers become large numbers.