7 Benefits of Offering a Vesting Schedule in Your Small Business 401(k) Plan

Author: Siân Killingsworth / Reviewer: Callie Adams Farnsworth, QKA, CAFCA
8 Jun 2023 / 401(k) Plan Information, Small Business 401k

If you own a small business, offering a 401(k) plan can be a great way to attract and retain talented employees. But if you want to make your plan even more appealing, consider adding a vesting schedule.

What is a Vesting Schedule?

A vesting schedule is a timeline that determines when employees have ownership of their employer’s contributions to their retirement plan. Without a vesting schedule, employees can lose all employer contributions if they leave the company too soon. This isn’t ideal for their future planning or for your small business’s reputation! By adding a vesting schedule, you can incentivize your employees to stay longer and reward them for their loyalty.

How Does a Vesting Schedule Work?

Vesting schedules typically have a set timeline for when employees become fully vested in their employer’s contributions. For example, you could implement a three-year vesting schedule, which means your employees become 100% vested in your contributions after three years of service.

Benefits of Offering a Vesting Schedule

1. Attract and Retain Talent: A 401(k) vesting schedule shows that you’re invested in your employees’ futures, and it also encourages them to stay with your small business for the long term.
2. Encourage Employee Loyalty: By offering a vesting schedule, you’ll encourage employee loyalty. Employees are more likely to stay with a company if they know they will be rewarded for their service.
3. Cost Savings for the Employer: A vesting schedule can also help you save money. If your employees leave the company before becoming fully vested, you’re not obligated to pay them the full amount of their employer contributions.
4. Increased Employee Retirement Savings: Employees are more likely to contribute to their retirement plan if they know their employer is contributing as well. A vesting schedule can motivate employees to save for retirement and ensure they receive the full benefit of your matching contributions.
5. Fairness for Employees: Without a vesting schedule, employees who leave the company early may not receive any of your matching contributions. A vesting schedule ensures that employees are rewarded for their service and receive the full benefit of your contributions if they meet the criteria.
6. Protection for Employer Contributions: If an employee leaves the company before becoming fully vested, your small business can retain the unvested portion of their contributions.
7. Compliance with Legal Requirements: The Employee Retirement Income Security Act (ERISA) sets minimum vesting requirements for retirement plans. By offering a vesting schedule, you can ensure your small business is in compliance with ERISA.

Types of Vesting Schedules

There are two main types of vesting schedules:

Cliff Vesting

Cliff vesting is when employees become fully vested after a certain period of time, usually three to five years. With cliff vesting, employees are either fully vested or not at all, depending on their length of service.

Graded Vesting

Graded vesting is when employees become partially vested over time. With graded vesting, employees earn a percentage of their employer’s contributions based on their length of service. For example, you could implement a six-year graded vesting schedule where your small business’s employees become 20% vested in your contributions after two years of service and earn an additional 20% for each subsequent year until they are fully vested after six years.

Considerations for Implementing a Vesting Schedule

Before implementing a vesting schedule in your small business 401(k) plan, consider the following:

1. Plan Design: Your vesting schedule should be designed to meet the needs of your business and employees. Consider factors such as employee turnover, industry standards, and company goals.
2. Communication: It’s important to communicate the vesting schedule to your employees clearly and regularly. Ensure they understand the plan’s benefits and the vesting timeline.
3. Administration: Vesting schedules require ongoing administration to ensure compliance with legal requirements and accurate recordkeeping. Consider hiring a third-party administrator to handle these tasks.
4. Costs: Vesting schedules can have costs associated with them, such as administrative fees and the cost of employer contributions. Consider these costs when designing your plan. (And look for a provider with good customer service and low, flat fees!)