Cliff vesting is a retirement plan that entitles employees to a percentage of their account balance after a set number of years. It can increase employee retention, but must meet legal requirements, including a maximum of five years to be fully vested and no vesting requirement on employee contributions.
The cliff vesting is a type of vesting program associated with retirement plans, such as 401(k), 457, and 403(b) plans. The term consolidation is used to define the percentage of an account balance to which a participant in a retirement plan is entitled.
Employers that sponsor a retirement plan often tie employer contributions to an vesting schedule. The reason for this is to entice participants to stay with the employer for a set number of years in order to be fully vested or entitled to those employer contributions. In this way, the use of an award program can increase employee retention.
The award schedule will allocate a percentage based on the years of service the employee completes. Some award schedules are based on a qualified schedule where the employee receives, say, a 20% award for each year. Such a schedule would mean that the employee is 100% or fully vested in the plan after five years of service.
The cliff grant schedule is not a qualifying schedule. It generally does not give the employee any vesting percentage until after the completion of a specific number of years of service. The number of years could be at least one and not more than five. When the target number is reached, the employee is 100% vested. It is known as a cliff grant program because of the 100% jump. For example, a 3-year cliff-off schedule means the employee is zero percent vested after years one and two, and then 100% when the schedule hits the cliff after the third year.
There are a few reasons why a bluff grant program can help with employee retention. An employee who terminates employment before becoming fully vested will lose all unearned money in his account. The loss is especially obvious because in most plans employees have daily access to see their entire account balance. Also, after reaching full vesting status, employees do not want to start over with a new vesting schedule in another company’s plan.
An important aspect of the cliff grant schedule that plan sponsors should be aware of is that it must meet certain legal requirements. Mainly that in no case are more than five years of service required to be fully acquired. Also, for 401(k) plans, the maximum number is three years.
Another requirement is that in the event an employee reaches normal retirement age as defined by the retirement plan, the employee must vest all rights. However, the employee would still need to be employed on that date.
In no event may a vesting requirement of any kind be imposed on employee contributions. Any money an employee contributes from their paycheck is essentially awarded immediately. The same rule applies to any money an employee puts into the plan.
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