A type of vesting schedule associated with retirement plans such as 401(k), 457, and 403(b) plans is referred to as Cliff vesting. The term vesting is used in order to define the percentage of an account balance that a participant in a retirement plan is entitled to.
Employers tie employer contributions to a vesting schedule
Mostly employers who sponsor a retirement plan use to tie employer contributions to a vesting schedule. The reason behind this is to entice participants to stay with the employer for a set number of years so that they may be fully vested, or entitled, to those employer contributions. In this way, the use of a vesting schedule may increase employee retention.
Percentage assigned by the vesting schedule
A percentage will be assigned by the vesting schedule based on years of service the employee completes. There are some vesting schedules that are based on a graded schedule where the employee receives, say, 20% vesting for each year. Such a schedule would merely mean that after five years of service the employee is 100%, or fully vested in the plan.
Cliff vesting schedule is not a graded schedule
The cliff vesting schedule is not a graded schedule. Usually it does not give any vesting percentage to the employee until after the completion of a specified number of years of service. The number of years could be between one and five. As soon as the target number is reached, the employee is 100% vested.
It is known as a cliff vesting schedule due to the jump to 100%. For example, the meaning of a 3-year cliff vesting schedule is that the employee is 0% vested after years one and two, and when the schedule reaches the cliff after year three then they are 100% vested.
Few reasons why a cliff vesting schedule may help with employee retention
I explain here few reasons why a cliff vesting schedule may help with employee retention. An employee by whom an employment is terminated before becoming fully vested will lose out on all of the non-vested money in his or her account. The loss is especially obvious due to the reason that in most plans employees have daily access to see their entire account balance. In addition to this, after achieving fully vested status, employees do not want to start over with a new vesting schedule in another company’s plan.
It must meet certain statutory requirements
An important aspect of the cliff vesting schedule plan about which sponsors have to be aware of is that it is necessary that it must meet certain statutory requirements. Primarily that in no cases does it need more than five years of service to be fully vested. Furthermore, for 401(k) plans, three years is the maximum number.
Another requirement is that in the event the employee must become fully vested when he or she reaches a normal retirement age as defined by the retirement plan. However, it is needed that the employee must be employed on that date.
It is not possible that in any case a vesting requirement of any type be placed on employee contributions. Any money that is contributed by an employee from his or her paycheck is essentially immediately fully vested. The same rule applies for any money that is rolled into the plan by an employee.
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