AGAINST ALL ODDS, vesting schedules have become the stuff of headlines.
Personal-finance writers around the U.S. are offering advice and insight into how employees should regard the schedule in which they vest in their employers’ contributions to their defined contribution retirement plans.
For workers in businesses that have shorter employee tenures, a long-graded vesting schedule could be seen as unfair to workers. But for plan sponsors, vesting schedules can control costs and help with employee retention.
Safe harbor plans must follow some clear vesting rules, but beyond that, sponsors have a lot of flexibility in strategically structuring their plan’s vesting. “My book of business is probably skewed toward non-safe-harbor plans,” says Joe DeBello, managing consultant at OneDigital Retirement + Wealth in Orlando. “So the topic of vesting is a constant in our discussions.”
Qualifying as a traditional safe harbor plan requires immediate 100% vesting for participants. A qualified automatic contribution arrangement safe harbor plan with automatic enrollment can have up to two-year cliff vesting, says Eric Droblyen, president and CEO of Employee Fiduciary, a Mobile, Alabama-based third-party administrator. “A lot of times, sponsors go with the QACA safe harbor instead of the traditional safe harbor specifically because they can do two-year cliff vesting,” he adds.
“I would say that more often than not, if somebody’s not forced to allow for immediate vesting in their plan, then most sponsors choose to subject participants to a vesting schedule,” Droblyen continues. ERISA does require that plan sponsors limit cliff vesting to a maximum of three years of service to become 100% vested, and graded vesting can take no longer than six years of service to become 100% vested. “Employers can definitely make their vesting rules more liberal, if they choose,” he says.
The End of Vesting?
One of the primary trends that Kristi Baker and her colleagues at CSi Advisory Services are seeing is sponsors shortening their plan’s vesting period. “We’re having a lot of conversations with our clients around how to recruit and retain employees, and in looking at their retirement plan holistically, one of the issues they’re looking at is, ‘Does a six-year vesting schedule still make sense, for the kind of employees we’re trying to attract?’” says Baker, managing partner at the Indianapolis-based firm. “I’m not seeing many plans use immediate vesting unless they’re a safe harbor plan, but more commonly we see a move to a three- to four-year graded vesting schedule.”
Some employers are doing that because the shorter vesting period is more attractive to employees, Baker says. Whether employees and potential new hires actually pay attention to vesting is industry-specific, she finds. “With some employers that have a lot of hourly or part-time workers, it never comes up,” she says. “But with employers that have more executive-level positions or professional-level positions, people do look into those kind of details now.”
Vanguard’s recent “How America Saves” report found that in 2021, nearly half of plans immediately vested participants in employer matching contributions, while 25% of plans with employer matching contributions used a 5- or 6-year graded vesting schedule. The report covers 4.7 million participant retirement accounts from the more than 1,700 plans for which Vanguard serves as recordkeeper.
Usually the first step in the vesting decision tree with plan sponsors is whether they’re going to go with a safe harbor design, says Jim Sampson, national practice leader for Hilb Group Retirement Services in Cranston, Rhode Island. If not, then an employer needs to start by understanding its goals for vesting. “Are they using vesting to try to retain employees for a certain period of time? Are they using vesting to protect the company’s money?” he asks.
At that point, Sampson also wants to understand whether the employer wants to utilize its retirement plan to help attract new employees. “That is becoming a much, much larger part of the equation in the past year or two,” he says. “Because they’re having a really hard time attracting new employees, a lot of companies now are trying to beef up their entire benefits package, especially the 401(k). We’ve seen a lot of companies go to immediate or shorter vesting. The thought is, if people have to wait years to get the money, it’s not necessarily seen as a strong benefit.”
“That’s especially true when you’re talking about a higher-level employee, in maybe a technical space or medical space,” Sampson continues. “We work with a lot of pharmaceutical and biotech companies, and they’re trying to pull people out of big, big employers, so they’re trying to mirror the benefits those big employers provide. Vesting is almost a non-starter for those companies. But in other workforces—such as restaurants, hospitality and retail—where turnover is high, having a vesting schedule can make sense to an employer.” It saves the company money when an employee leaves quickly, and potentially can motivate employees to stay longer.
Sampson understands the strategic value that some employers see in having a vesting schedule. “But the reality is that vesting might be becoming a dying breed, in this post-COVID workforce we’re all experiencing. Vesting might go out the window because companies find that it’s a detractor to hiring good people,” he continues. “We live in an instant-gratification world: People want it now, and the end of vesting might be a byproduct of that.”
The Conversation Is Changing
Droblyen is asked about the pros and cons, from an employer perspective, of immediate vesting versus having a vesting schedule. “Simply put, if a sponsor goes with immediate vesting, it’s seen as a more generous plan for employees: That money is their money, as soon as it hits their account,” he answers. “The ‘pro’ of having a vesting schedule is that you’re getting some money back, if somebody doesn’t stay with you for long.”
The decision “boils down to a tradeoff” for employers, Droblyen says. “You need to pick what you think is more valuable to your business. Is it more important to have immediate vesting that’s seen as a more valuable benefit by employees, or is saving some money for the employer more valuable? I wouldn’t say there’s a hard-and-fast rule to answer that: It’s more facts and circumstances for individual employers.”
DeBello has read with puzzlement recent media coverage criticizing employers that have a vesting schedule. He doesn’t see a fairness issue with promoting the concept of an employer match to employees as “free money,” while also having multi-year vesting. “We very rarely see employers that tout, ‘It’s free money, with no strings attached.’ If you go on participant sites, almost every modern recordkeeping system is going to show participants their total balance and their vested balance. And every group education meeting for a plan that I’ve been to covers vesting,” he says. “I don’t subscribe to the idea that this is some kind of ‘bait and switch’ or mystery to employees. It is something that employers do strategically, to mitigate costs and hopefully to retain employees.”
For employers with a vesting schedule, the key is to communicate clearly about it with employees and potential hires, Baker says. “Vesting is one of the topics we often talk about in employee meetings, and we explain it in a way that’s straightforward and simple to understand: Vesting in the employer money is based upon an employee’s years of service they have with the company,” she says. “We don’t get much pushback on that.”
The debate about vesting really speaks to a broader issue that’s worth considering, DeBello thinks. “The heart of this issue is, these vesting schedules tend to impact lower-income parts of the workforce that are moving between jobs more,” he says. “I think the bigger issue with retirement security for lower-income employees is coverage: whether an employer offers a retirement plan to its employees. We’re spending too much time focusing on something [vesting] that isn’t the big issue for retirement savings.”
“The employer is giving you money as an employee, and expecting loyalty in return. I think there is nothing wrong with that,” DeBello says. “But the conversation around vesting is changing, and I have to acknowledge that. The types of jobs out there are changing—there are more ‘gig economy’ jobs, and service jobs—and maybe the conversation about vesting needs to change, too.”
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