Retirement Plans for SMBs: What is Vesting?

Retirement Plans for SMBs: What is Vesting?

Written by The Peppermint Team

Peppermint was created by a group of business owners, entrepreneurs, and benefits experts who have been on both sides of the table as employees and employers.

March 29, 2022

Understandably, there are a lot of terms that can be confusing when it comes to 401ks and other types of retirement plans. You might be wondering:

What is vesting?

Vesting refers to the amount of ownership employees have over funds that their employers have contributed to a 401k, PEP, or other retirement plan.

In this article, we’ll explain what a vesting schedule is and show why it’s valuable to consider for both employees and employers alike when choosing a retirement plan.

Vesting 101 

Vesting is what legally gives employees’ the right to own funds that have been contributed by the employer to the retirement plan. It is measured by the amount of time that an employee is required to stay in your company in order for them to be able to acquire the full amount you’ve contributed.

Both employee and employer contributions have their own vesting, wherein employees automatically get 100% of the money they put in (of course, it’s their own money after all!)

However, as the employer, your contributions are voluntary and you can subject these to a vesting schedule in order to give your employees incentives to stay in your company longer. There are many ways to set up your vesting schedule depending on how you want to stagger your matched contributions to your employee’s retirement plan. 

Don’t worry, we’ll be discussing the different kinds of vesting schedules available so you can see which one is best for your company and your employees.

What is a Vesting Schedule?

A vesting schedule is basically the duration at which your employee is required to stay in your company before he/she can earn full ownership of the contributions you made to their retirement plan. 

What’s the bottom line? It’s a retention strategy that business owners like you can use to your advantage. 

There are several kinds of vesting schedules and we’ll briefly touch on each of them.  Then, we’ll highlight the schedules we use here at peppermint for our pooled employee plans.

Cliff Vesting

This vesting schedule gets its name from the fact that once employees meet the duration required for the vesting, they’ll get 100% ownership of the employer contributions all at once. It’s basically like jumping off a cliff. If your employee leaves anytime before the vesting period has lapsed, they forfeit all their benefits. According to federal law, cliff vesting for qualified retirement plans like 401ks should not exceed three years.

Graded Vesting

Graded vesting schedules are a bit more flexible for business owners compared to cliff vesting. They gradually increase the percentage of the employee’s ownership of the employer contributions. Your employee’s ownership will increase with their tenure until they reach 100% ownership. If the employee leaves before they reach full ownership, then they will only keep the percentage of the contributions they were vested. Law states that there is a six year limit on graded vesting schedules.

Immediate Vesting

This is a generous vesting schedule as you give your employees the right to 100% of employer contributions the moment their retirement plans are activated.

Vesting Schedules with peppermint

Our safe harbor plan options (Match and Easy) are only able to operate with an immediate vesting schedule. This is because safe harbor options require less compliance testing and fees. 

On the other hand, our non-safe harbor plan (Discretionary/Flex) allows for both graded vesting or cliff vesting options, depending on your needs. Since this option gives more flexibility to the employer when it comes to contribution and vestment, it’s also subject to compliance testing, fees, and the possibility of liability if legal actions arise.

The Importance of Vesting Schedules

Vesting schedules protect business owners like you from unscrupulous individuals who are looking to take advantage of generous company benefits. At the same time, it also makes for a good retention strategy as creating vesting schedules that require tenure will make employees think twice before jumping ship. It’s a good way to promote employee loyalty as well, as the more years they spend with your company, the more likely they are to be committed towards your goals and mission. 

However, this kind of policy comes with a catch: You’ll need to think twice about putting your employees through tenure requirements or other barriers when it comes to their 401k.

This kind of freedom and flexibility also comes with a price. The non-safe harbor options will cost you more money due to testing and compliance requirements. This is to ensure that employee welfare is also protected and that business owners aren’t being unfair when it comes to contributing to their employees’ benefits. After all, unscrupulous business owners can be unfair by employing friends and family, contributing large sums to their retirements plans, while contributing little to others. Testing prevents those kinds of instances.

In addition, failing one of the IRA mandated compliance tests and requirements will definitely cost you a lot in penalties and other payments as you will need to make up for any unequal contributions made to less paid employees.

Ultimately, What Do You Need?

At the end of the day,  the kind of 401k plan that you will get for your business and your employees will depend on your business needs and capabilities. Peppermint has several plans available that can cater to the retirement needs of any small- or medium-sized business.

Our retirement plan specialists are here to help you find the right plan. Get in touch with peppermint by scheduling a callback here or leaving us with your contact information here. We are looking forward to serving you.

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