Vesting RequirementsVesting rules specify how long employees must participate in a retirement plan before their accrued benefits become irrevocable. Employees who leave a job without being fully vested in their pension forfeit all or part of those benefits. Therefore, employers--especially those that depend on workers who have received considerable specialized training--may favor long vesting periods to reduce turnover among employees and minimize their own training expenses. The vesting rules that apply to qualified plans, however, mandate relatively short vesting periods. That feature enhances the mobility of the labor force but discourages employers from offering retirement plans. Under the rules, employees are always 100 percent vested in benefits that are attributable to their own contributions. For benefits that are attributable to an employer's contributions, plans must generally use either "graded" or "cliff" vesting. What follows are the longest allowable vesting periods. Employers may always use shorter ones. Under graded vesting, employees become vested in 20 percent of their accrued benefits after an initial period of service; they become vested in an additional 20 percent in each subsequent year, with full vesting four years later. The initial period depends on how employers determine the amount of their contributions. If an employer's contribution is a fixed percentage of an employee's contribution, then the initial period of service is two years, with full vesting after six years. If an employer's contribution is unrelated to an employee's, then the initial period of service is three years, with full vesting after seven years. (Before the passage of EGTRRA, the seven-year period applied regardless of how an employer's contribution was determined.) Under cliff vesting, employees remain unvested during an initial period of service but become fully vested after that. The initial period of service depends on how employers determine the amount of their contribution. If an employer's contribution is a fixed percentage of the employee's contribution, then the initial service period is three years. If an employer's contribution is unrelated to the employee's, then the initial service period is five years. (Before EGTRRA, the five-year period applied regardless of how the employer's contribution was determined.) If an employer imposes a two-year waiting period on eligibility rather than the standard one year (see nondiscrimination rules), participants must be fully vested immediately upon becoming eligible. Furthermore, if a plan is terminated, all participants immediately become fully vested. Among defined-benefit plans in the private sector in 2002, 82 percent of covered employees faced five-year cliff vesting. Vesting for public employees is similar to that for private-sector employees. All federal workers and approximately half of state and local employees face five-year cliff vesting in their basic pensions. Ten-year cliff vesting is also common among plans for state and local government employees because the plans are not subject to qualification rules. Graded vesting is rarely used by defined-benefit plans in either the public or private sectors. Vesting in a defined-contribution plan applies to contributed funds and their investment earnings rather than to promised benefits (as in a defined-benefit plan). More than one-quarter of employees of private businesses with 401(k) plans in 2002 were immediately vested, and another fifth were vested under the five-years-or-less cliff vesting method. Nearly half (47 percent), however, were vested through a graded method; periods of four to seven years were the most common. Most employees are fully vested in defined-contribution plans after five years of service. If an employee leaves, he or she typically has the choice of rolling funds over into an IRA or a new defined-contribution plan, or of leaving the funds invested until retirement.
|