W Choosing Vesting Requirements for QUALIFIED RETIREMENT PLAN PURPOSES BY KRISTOFFER AAS, ASCENSUS While vesting standards have long existed to retain and reward employees, a financial literacy gap can prevent participants from maximizing their vesting opportunities and employers from reusing the nonvested (or forfeited) contributions when an employee terminates employment. The literacy gap can have an even bigger effect on employees who frequently move from one job to the next. What Is Vesting? Vesting is the process by which employer contributions become nonforfeitable to participants by earning years of vesting service. When a participant terminates employment and requests a full distribution, the vested percentage determines how much of the employer contributions can be distributed and how much (if any) is forfeited back to the employer. Some contributions are immediately vested (e.g., elective deferrals, rollovers, after-tax employee contributions), and some are subject to a vesting schedule (i.e., profit-sharing contributions or employer match). Safe harbor contributions1 can fall into either category depending on the type and purpose. What Are the Permitted Vesting Schedules? How long must an employee serve their employer before becoming fully entitled to employer contributions made on their behalf? The maximum permitted vesting schedule2 for a defined contribution plan is either a six-year graded or a three-year cliff schedule. The six-year graded schedule gradually increases 20% for every year of service from year two to year six, while the three-year cliff schedule increases from zero percent to 100% after three years of service. While an employer may choose a more favorable schedule, it must at least satisfy these minimum vested percentages at those specific years of service. For example, if an employer elects a four-year graded schedule, year two must be at least 20% and year three must be at least 40%. While an employer may not combine a graded and a cliff schedule under the same contribution type, it can generally choose a different type of schedule for each contribution type (i.e., a graded schedule for matching contributions and a cliff schedule for profit-sharing contributions). How Is Service Toward Full Vesting Measured? The same service-crediting methods3 that apply for determining whether a participant has met a plan’s eligibility conditions also apply in determining the extent to which vesting requirements have been met. These are the “actual hours” method, the “equivalency hours” method and the “elapsed time” method. There is a significant difference, however. For eligibility purposes, if an employer elects either the actual hours or the equivalency hours method, the participant must wait until the end of the 12-month computation or measuring period to earn a year of service. However, when determining service for vesting purposes, the participant will earn a year of service immediately upon satisfying the hourly requirement (no more than 1,000 hours can be required). In other words, they do not have to wait until the end of the 12-month period.4 HUMAN RESOURCES MARCH/APRIL 2025 49
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