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When Should Your 401(K) or 403(b) Plans Vest for Employees?

February 11, 2022

By Anthony Kaylin, courtesy of SBAM Approved Partner ASE

Many organizations offer a 401(K) for employees.  Some are very generous, some not so much. About 98% of companies that offer a 401(k) plan make regular contributions to workers’ retirement savings, according to a survey by the Plan Sponsor Council of America (PSCA). 

Contributions come in two ways.  First, they could be a match of pay, likely up to 3% to 6% of pay.  They could also be a defined contribution of up to 8%, for example, without a match.  Or they could be a percentage based on company profits or profit share. 

ASE’s 2021-2022 Michigan Benefits and Policies survey shows that the about 60% of respondents who offer a 401(K) match 2.5%-4.9%, with the majority using a 3% approach.  If they provide a profit share, 67% would give 1.0%-3.9% of salary.  67% of respondents gave a profit share to employees.  60% of respondents will automatically enroll an employee at the 3% match rate.

The next question is when can an employee utilize the 401(K)?  Surprisingly, only 23% allow immediate participation.  Another 23% make the employee wait a month, and 80% allow employees participation after 6 months.  Finally, 86% of respondents will have allowed employees to participate by end of the first year. 

Yet, when do these monies vest to the workers? Companies use different timelines, or vesting schedules, to determine how long it takes for savers to fully own the employer contributions. In some cases, they must work at a company at least six years before the funds are theirs, or risk forfeiting matches and investment earnings if they walk away early.

According to the PSCA survey, about 41% of 401(k) plans offer immediate full vesting of a company match. The rest use either a “cliff” or “graded” schedule to determine the timeline. Federal rules require full vesting within six years.  About a third of 401(k) plans use a graded five- or six-year schedule for the company match, according to the PSCA survey. This formula is most common among small and midsize companies.   And a year of service does not directly equate to a full-time 2080 hours a year employee.  Under the law, a “year of service” generally means 1,000 hours worked over 12 months.

ASE’s 2021-2022 Michigan Benefits and Policies survey shows that about 30% of respondents allow for immediate vesting, with 24% at graded 6 years, and 15% at 5 years.  Our survey also found that about 83% of respondent’s employees participate in these plans.

Employees today don’t look at employers for lifetime employment, but generally last 3-4 years until they switch to new jobs for whatever reason.  So, the cost of additional compensation via 401K may be more practical than higher salaries, which cannot be supported over time if the organization has pricing pressures. 

So, in today’s marketplace with workers having the power to choose employers, anything that could make a decision easier should be considered.  Employers will need to weigh the pros and cons to lessor participation and vesting periods.  Generally, the administrative cost for immediate participation is not significant.  Any coordination of these benefits with student loan repayments would be a positive for potential and actual employees with student loans.

SBAM understands what small businesses dislike about 401(k) plans – the cost, the time and really not understanding their fiduciary responsibilities. The SECURE Act now allows employers from all industries and sizes to band together to create a new type of retirement plan:  Pooled Employer Plan (PEP). Our partnership with TAG Resources, Transamerica, and Graystone Consulting will help small businesses increase administrative efficiencies, reduce fiduciary risk and safe your employees money. Learn more!

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