What Is Cliff Vesting?

Cliff vesting is the process by which employees earn the right to receive full benefits from their company’s qualified retirement plan account at a specified date, rather than becoming vested gradually over a period of time. The vesting process🍬 applies to both qualified retirement plans and pension pla𝓡ns offered to employees.

Companies use vesting to reward employees for the years worked at a business and for helping the firm reach its financial goals. 澳洲幸运5官方开奖结果体彩网:Graduated vesting, in which benefits accelerate💎 with time, is the opposite of cliff vesting.

Understanding Cliff Vesting

Cliff vesting is more commonly used by startups because it enables them to evaluate employees before committing a full range of benefits to them. For employees, cliff vesting can be an uncertain affair with pros and cons. While it ಞoffers the advantage of cashing out all at once and potentially quickly, cliff vesting can be more risky for employees if they leave a company ahead of the vesting date, or if the company is a startup that fails before the vesting date.

In some cases, an employee can also be fired 💎before the vesting date. This means that they lose access to the benefits promised earlier. The typical cliff vesting period is usually somewhere between one and five years, but could be longer in some cases. Upon maturity of the vesting period, employees can roll over their full account balance into a new 401(k) or make a withdrawal. Before vesting, employees only have access to funds they contributed and not those contributed by the employer.

Defined Benefit vs. Defined Contribution Plans

When an employee becomes vested, the benefits the worker receives are different depending on the type of retirement plan offered by the company. A 澳洲幸运5官方开奖结果体彩网:defined benefit plan, for example, means that the employer is obligated to pay a ♑specific dollar amount to the former employee each year, based𝕴 on the last year’s salary, years of service and other factors.

On the other hand, a 澳洲幸运5官方开奖结果体彩网:defined contribution plan means that the employee and not the employer is the primary funder of the retirement plan. It also, means that retirement benefits are not guaranteed and depend on the contributions made and investment performance. Under a defined contribution plan, employees must contribute to fund the plan, these contributions are typically taken out of the employees paycheck. Employers will then often match the employees contributions up to a certain percentage of their salary, often 3% to 5%. Employees can also contribute beyond this amount, up to IRS limits, without further matching. Employers are not required to match and contribute at all, although most do. The Pension Protection Act of 2006 requires either a 3-year cliff vesting period or a 6-year graded vesting period for defined contribution plans.

Examples of Vesting Schedules

Assume that Jane works for GE and participates in a qualified retirement plan, which allows her to contribute up to 5% of her annual pre-tax salary. GE matches Jane’s contributions up to a cap of 5% of her salary. In year one of her employment, Jane contributes $5,000 and GE matches by putting in another $5,000. If Jane leaves the company after year one, she has ownership over the dollars she contributed, regardless of the vesting schedule for the amount GE contributed. But whether she has access to GE's $5,000 contribution depends on whether GE used cliff vesting and if so, what that schedule looks like.

GE, Jane’s employer, is required to communicate the vesting schedule to employees and report the qualified retirement plan balance to each worker. If GE set up a four-year graded vesting schedule, Jane would be vested in 25% of the company’s $5,000 contributions at the end of year one. She would be able to take $1,250 of GE's contributions with her, but would lose the rest. On the other hand, a three-year cliff vesting schedule would mean that Jane is not eligible to keep any of the employer contributions in this scenario.