Are vesting schedules still effective?
Vesting schedules have traditionally been used by employers to manage retirement plan costs while encouraging employee loyalty. But new research shows they may not be as effective at retaining employees as once thought, though they still offer financial advantages to employers.
What is vesting, and how does it work?
“Vesting” means ownership of retirement plan funds. Employee contributions are always 100% vested; however, employees earn the right to employer contributions over time, based on years of service or hours worked. If an employee leaves before fully vesting, the unvested portion goes into the plan’s forfeiture account. Vanguard reports that over half of the plans it administers include a vesting schedule for employer contributions.
Vesting schedules are defined in the plan document and may vary:
- Immediate Vesting: Full ownership from day one.
- Cliff Vesting: 0% vested until a set number of years, then 100%.
- Graded Vesting: Ownership increases gradually each year.
The table below shows the differences between a cliff vesting schedule and a graded vesting schedule. For cliff vesting, the account becomes 100% vested after a set number of years, whereas a graded vesting schedule has gradual increases over a set number of years. This example reflects a three-year cliff vesting schedule and a six-year graded vesting schedule.
| Years of Service | Cliff Vesting | Graded Vesting |
| 1 | 0% | 0% |
| 2 | 0% | 20% |
| 3 | 100% | 40% |
| 4 | 100% | 60% |
| 5 | 100% | 80% |
| 6 | 100% | 100% |
Why do employers use vesting schedules, and what did Vanguard’s research reveal?
Employers who use vesting schedules are generally motivated by two main goals: retaining employees by encouraging them to stay longer in order to earn full benefits and managing costs by recouping unvested contributions when employees leave the company.
Vesting schedules are a common strategy used by about two-thirds of employers to promote retention, but their effectiveness is often limited by a lack of employee understanding. Many workers are unclear on how vesting works, which diminishes its intended impact.
A research report by Vanguard further challenges the idea that vesting schedules significantly influence employee retention. When comparing plans with immediate and three-year cliff vesting, they found no major differences in turnover, and many participants weren’t even aware their plan included a vesting schedule, highlighting a communication gap.
Employers benefit financially by recouping an average of 2.5% of contributions through forfeitures. However, these savings often come at the expense of lower-income employees, whose final retirement balances may be reduced by about 40%. This underscores the need for plan sponsors to balance the cost-saving benefits of vesting schedules with their potential negative impact on lower-paid, high-turnover workers.
What should plan sponsors do?
1. Review Your Plan Documents
Confirm if your plan has a vesting schedule and how it works.
2. Know Who Manages Vesting
Vesting is typically tracked by the plan sponsor, recordkeeper, or third-party administrator (TPA).
3. Communicate Clearly
Help participants understand the vesting schedule because it could influence their decisions and boost retention.
4. Understand Forfeiture Rules
Know how forfeitures can be used (e.g., offsetting employer contributions or plan expenses) and ensure compliance with your plan document.
Want help understanding or reviewing your plan’s vesting structure? Reach out to your Shepherd Financial advisor today.
i Plan Sponsor Council of America, 67th Annual Survey of Profit-Sharing and 401(k) Plans.
ii Internal Revenue Service.
iii How America Saves 2024, Vanguard, available at: institutional.vanguard.com/insights-and-research/report/how-america-saves.html.
iv Plan Sponsor Council of America, 67th Annual Survey of Profit-Sharing and 401(k) Plans.
v Does 401(k) vesting help retain workers?, Vanguard, available at: