Many American workers have access to 401(k) plans that can help them save for retirement. With extremely high contribution limits, matching contributions from many employers, and tax-deferred growth, a 401(k) has a lot of benefits that make can it the most attractive option for your savings.
However, there are some downsides to 401(k) plans that you need to understand. Under certain situations, your employer can force you to forfeit a portion of the money you have in your 401(k) account. There are things you can sometimes do to prevent 401(k) forfeitures, but the sooner you're aware of the potential problem, the easier it will be to plan accordingly.
Forfeiture and matching contributions
401(k) forfeitures center on the matching contributions that some employers make on behalf of their employees. Employer matches are meant to give workers an extra incentive to set money aside in their 401(k)s, adding to their eventual retirement savings and providing some supplemental financial resources after their careers are over.
Employers are allowed to choose from several options as far as how they deal with matching contributions. This decision concerns when employees become vested in their employer matches. Some employers provide for immediate vesting of matching contributions as soon as they're made, and in that case, no 401(k) forfeiture can ever take place.
Other vesting options open the door to potential forfeiture of 401(k) funds. With graded vesting, an employer gradually allows a portion of employer contributions to become vested over time. For instance, a vesting schedule could provide for you to become 20% vested in employer contributions after you've worked in your job for two years, with additional boosts of 20 percentage points each year until you reach your sixth work anniversary. At that point you'd become fully vested.
With cliff vesting, none of your employer contributions become vested until one date, after which all of those contributions vest. There's no gradual release of portions of those employer contributions; it's an all-or-nothing proposition that can happen under current law as long as three years after you begin work.
How much can you forfeit?
If you leave work before you've become fully vested, then you can lose all or a portion of the contributions that your employer made on your behalf. If you're 20% vested under a graded vesting schedule, then you'd forfeit the remaining 80%. If you haven't reached the appropriate length of service under a cliff vesting schedule, then you'll lose all of your employer contributions.
The forfeiture amount is based on what your employer holds in the employer contribution portion of your retirement account. Accordingly, you'll end up forfeiting not only the original contribution but also any earnings that those contributions have generated over time.
One thing to be absolutely clear about is that your own employee contributions that you've made from your own pay are always 100% vested and never subject to forfeiture. Any employer who suggests that you need to forfeit your own employee contributions is mistaken.
How to avoid 401(k) forfeiture
The easiest way to make sure that you won't have to forfeit employer contributions in your 401(k) plan account is to stay employed long enough to become fully vested in your plan account. If you're considering voluntarily leaving your job, staying an extra week or two can make a big difference if you're near your work anniversary date and will see an increase in the percentage of employer contributions that become vested.
Unfortunately, if you're being laid off or let go involuntarily, then there's not much you can do to protect your account from 401(k) forfeiture. Trying to negotiate the timing of a layoff might be an option if you're close to a work anniversary, but don't count on employers working with you.
The key takeaway is that your own employee contributions are never subject to forfeiture, and you can always count on them being there to help you in retirement. Don't let fear of forfeiture keep your from contributing to a 401(k), and take steps when you're considering a change of employment to ensure that you keep as much of those employer contributions as possible.
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