Is the 401(k) match really a free lunch?

Vesting schedules can dictate how attractive a 401(k) match is.

When it comes to the hierarchy of allocating money, a 401(k) up to the match is almost always the right place to start. Of course, this assumes there is at least some type of emergency fund and no high-interest credit card debt in place.

The 401(k) match is an amazing tool to grow wealth, and leaving any piece of it on the table is usually a very poor move.

Essentially, your employer is saying, “Hey, if you contribute 3% of your salary to your 401(k), we will match every single dollar you do.” That’s an immediate 100% return… Most want to make sure they are taking advantage of that to the maximum extent.

The example above is just that, an example. 401(k) matches will vary across employers. I have seen some incredibly generous matches going to dollar for dollar up to half the annual contribution limit. For reference, that would be an additional $11,750 in contributions in one year… pretty awesome!!

I have also seen firms (mainly law firms) match nothing.

But while the 401(k) match is amazing, there’s a catch. I bring this up mainly because it is relevant to younger professionals.

The vesting schedule. Some plans have no vesting requirement, which is the most generous. The least generous vesting schedules are usually a 3-year cliff vesting schedule or a 6-year graded schedule.

For a quick overview of each, this is how vesting would look:

3-year cliff vesting schedule:

Year 1: 0%

Year 2: 0%

Completion of year 3: 100%

6-year graded vesting schedule:

Year 1: 0%

Year 2: 20%

Year 3: 40%

Year 4: 60%

Year 5: 80%

Year 6: 100%

Now, why is this so important for young professionals? What immediately comes to mind for me is the number of young people who seek 1-2 years’ worth of professional experience before heading back to graduate school. Additionally, it is not uncommon for young professionals to change jobs frequently.

This can have a major impact on the efficiency of allocating to a 401(k). The 401(k) outside of the match is usually much lower on the hierarchy of where to direct savings.

So, in the event someone left work after 2 years, contributed to their 401(k) on the premise of the match being “free money,” and was subject to a 3-year cliff vesting schedule, they’d forfeit their entire match.

When starting a job and beginning contributions to a workplace retirement plan, understanding the employer match and the vesting schedule are key. Don’t get caught off guard allocating under the false premise that the match is “free money.” If the employer uses a less generous vesting schedule, the 401(k) may not be the most optimal place to save!