You’ve almost certainly heard that if you’re saving for retirement, taking full advantage of your 401(k) employer match should be your first step. That match represents an immediate 50% to 100% return on investment, which is better than anything you’ll find anywhere else.
It’s the standard advice because it’s good advice. Making sure you’re getting the full employer match should almost always be the first step in your retirement savings plan, no matter what other options you have available to you.
But there’s a catch to this advice that’s often overlooked and it’s called vesting.
If your 401(k) has a vesting policy, those employer contributions may not be yours right away. And while that doesn’t often mean you should skip your employer match, it can make that match less valuable than you think.
What Is 401(k) Vesting?
If your 401(k) has a vesting schedule, that simply means that you have to work for the company for a certain amount of time before any employer contributions to your 401(k) are 100% yours.
For example, your company might have a policy in which 20% of your employer contributions vest each year. That means that if you leave your company before you’ve been there at least one year, you won’t get to take any of those employer contributions with you. After one year, you’d get to take 20% of the value of those contributions with you. After two years, it would be 40%, and after five years you’d have 100% ownership of all the money your employer has contributed to your 401(k).
It’s important to note that we’re only talking about employer contributions here. Contributions YOU make to your 401(k) are always 100% yours, though of course the value of those contributions will rise and fall with the market.
It’s also worth noting that there’s a single vesting clock for all employer contributions. Once you’re 100% vested, ALL employer contributions are 100% vested no matter when they were made, including all future contributions. There isn’t a separate clock for each individual contribution.
But the point here is that it might be a year before any portion of those employer contributions are yours, and it may be up to five years before they’re completely yours.
Which means that your employer match may not be quite as attractive as it initially seems.
How to Find Your 401(k) Vesting Schedule
The best way to find out if your 401(k) has a vesting schedule is to ask your human resources representative for a copy of your 401(k) plan’s summary plan description and to search through it for the section on vesting. Your company’s policy will be spelled out there. You might even find that you’re 100% vested in all employer contributions right away.
If you have any questions about it, you can ask your HR representative for clarification. You can also ask them for your official employment start date so that you know how long you’ve been with the company, and therefore how far along the vesting schedule you are.
Another good source of information is your most recent 401(k) statement, which should show you how much of your 401(k) balance is attributable to employer contributions. You can then multiply that amount by your current vested percentage to figure out how much of that money would be yours if you left the company today.
For example, let’s say that your total 401(k) balance is $40,000 and that $10,000 of that is attributable to employer contributions. If you’re currently 40% vested, that means that:
- The $30,000 attributable to your own contributions is 100% yours.
- $4,000 of the $10,000 attributable to employer contributions is yours.
- If you left the company today, your 401(k) would be worth a total of $34,000.
How Vesting Should Factor into Your Retirement Savings Plan
So the big question is this: When should your vesting schedule prevent you from prioritizing your employer match over contributing to other retirement accounts?
The short answer is rarely. Because let’s say that your employer has a relatively stingy matching policy where they only match 50% of your contribution, and those contributions vest 20% every year.
Even in that situation, staying with the company for one year means that you get a 10% return on your investment just from your employer contribution (20% of 50% is 10%). Given that long-term returns from the stock market are expected to be in the 7% to 8% range and always come with some uncertainty, a guaranteed 10% is a very good deal.
And let’s say that it doesn’t work out with that company, and you don’t end up staying there for even a full year. You wouldn’t end up getting any match, but you’d still get all the other tax benefits of a 401(k). It wouldn’t be ideal, but even the worst-case scenario is good.
Still, there are some scenarios where you may want to save money elsewhere first.
For example, the IRS allows companies to wait three years before any of their contributions vest, at which point their contributions immediately vest 100% (see “cliff vesting” here). If that’s your company’s vesting policy, and if you don’t plan on staying with the company for three years, and if your 401(k) has low-quality, high-cost investment options, then it might be worth prioritizing an IRA or health savings account ahead of your 401(k).
Your vesting schedule might also be worth considering if you want to change employers. It certainly shouldn’t be the driving factor, but if you’re just a couple of months away from a significant increase in your vested percentage, it may be worth sticking it out a little longer.
- Related: Five Signs You Need a Career Change
Are You Vested?
In most cases, your 401(k) employer match is a good deal even with a vesting schedule in place. You are almost always entitled to something after one year with your company, and in that case the risk is low and the reward is high.
Still, it’s worth understanding your vesting schedule just so you know exactly how valuable that employer match is. Better to find out now than to be surprised later on when you get less than you thought.
- What to Do If Your 401(k) Stinks
- 401(k) Contribution Limits for 2017
- A Complete Beginner’s Guide to 401(k) Plans
- What to Do With Your 401(k) When You Change Jobs
Matt Becker, CFP® is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.