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The Debate Over Vesting Schedules in Retirement Plans

As employers continue to grapple with employee turnover, there has been a shift in focus to retirement plan vesting schedules. Recent evidence suggests that plan sponsors are shortening their plan’s vesting periods in an attempt to attract and retain employees; however, there remains disagreement in the employee benefit plan industry about whether vesting schedules may in fact disappear.

Safe harbor plans must follow clear vesting rules (e.g., qualifying as a traditional safe harbor plan requires immediate 100% vesting for participants; a qualified automatic contribution arrangement safe harbor plan with automatic enrollment can have up to two-year cliff vesting), but beyond that, sponsors have a lot of flexibility in strategically structuring their plan’s vesting. More often than not, if a sponsor is not forced to allow for immediate vesting in their plan, then most will choose to subject participants to a vesting schedule. Currently, ERISA requires that plan sponsors limit cliff vesting to a maximum of three years of service to become 100% vested, and graded vesting can take no longer than six years of service to become 100% vested.

Despite the historical vesting trends, sponsors are starting to reconsider their plans’ vesting periods and asking themselves if they still make sense given the type of employees they are trying to attract. Advisers across the country are seeing moves to three- and four-year graded vesting schedules more consistently, and it appears as if potential job candidates are paying more attention to vesting as well (especially in executive-level and professional-level positions).

When deciding on a vesting schedule, a sponsor should first determine whether they are going to utilize a safe harbor design. If not, the sponsor should evaluate its goals for vesting. That is, are they trying to retain employees for a certain period of time, or are they trying to protect the company’s money? The sponsor should also determine if they want to use its retirement plan to help attract new employees. The desire for the latter has become quite prevalent in the past few years. Sponsors have been busy trying to create more attractive benefit packages, especially 401(k) plan offerings. The thought is that employees do not want to wait for years to be able to access their money. In this world of “instant gratification,” people want things now. And the end of vesting might be a byproduct of that.

From an employer’s standpoint, when considering the pros and cons of immediate vesting versus having a vesting schedule, the resounding answer is that immediate vesting is more generous for employees. On the flip side, having a vesting schedule means that the employer is getting some money back if an employee leaves before he/she is fully vested. Employers and sponsors need to choose what is more valuable to their business. Is it more important to have immediate vesting that is seen as a more valuable benefit by employees, or is saving some money for the employer more valuable? There is no one right answer.

Vesting schedule or not, the key is for employers/sponsors to communicate clearly about it with employees and potential hires. This area has become a hot topic in recent years and will no doubt continue to spark debates as the employment landscape evolves. Please contact us if you have questions about the information outlined above, our seasoned and experienced employee benefit plan professionals are here to help. You can also learn more about our Employee Benefit Plan Audit  services by visiting our website.

About the Author

Steph Kramer

Steph joined McKonly & Asbury in 2016 and is currently a Manager in the firm’s Audit & Assurance Segment. Steph audits a broad spectrum of employee benefit plans, including 401(k), 403(b), retirement, profit sharing, health and… Read more

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