Investing money through an employer-sponsored 401(k) is one of the easiest ways to begin saving for retirement. In fact, according to the Pension Rights Center, 56% of all eligible workers participate in a workplace retirement plan. This includes 401(k) accounts and 403(b) retirement savings plans offered to public school employees, charitable organizations, and healthcare staff. While investing through a 401(k) is generally easy to do, there are some common 401(k) mistakes that can cost you big time, and one of the biggest is not checking the years required for employer contributions to fully vest. This small mistake can cost you thousands of dollars if you leave your job.
Vesting is the process in which an employer’s contributions to a 401(k) plan transfer ownership to the employee over time. Workplaces are not required to set vesting schedules by the IRS. However, if they do, they can choose between two frameworks: a vesting cliff where employees receive 100% of employer contributions after three years, or a longer-term graded vesting schedule. In the latter option, employees gradually get ownership of increasing percentages of their employer’s contributions for up to six years before they’re fully vested. Employers often set this stipulation in their compensation plan to reduce quick employee turnover, as workers who leave a job before the company’s contributions are fully vested may forfeit some of their earnings.
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Exactly what happens to your 401(k) when you quit varies, and the amount you can lose out on by leaving a job before being fully vested hinges on multiple factors including salary, pretax contributions, and employer match percentage. Say an employee earning $80,000 a year contributes 6% to their 401(k); this in turn gets them a 100% match from their employer. If they left just before their two-year anniversary, the employee would have automatically contributed $19,200 toward retirement savings, with $9,600 coming from payroll deduction and $9,600 from the employer. If the employer used a graded vesting schedule, $9,600 in employer contributions would be lost, but the employee would keep the $9,600 they contributed from their paycheck.
While leaving a job is ultimately a personal decision, it’s a good idea to check with human resources or plan administrators to see if your employer has a vesting schedule for 401(k) contributions. Similarly, you should know what other stipulations your employer has if you leave your job. For example, some may automatically cash out your plan, which would pull your assets out of the stock market and cause you to pay taxes and early withdrawal penalties. In other cases, employers will require you to pay back the amount due if you borrow against your retirement savings through a 401(k) loan.