What Is 3 Year Cliff Vesting and How Does It Work?

Employer-sponsored benefit plans often include contributions subject to specific rules before an employee gains full ownership. These rules determine when an employee’s right to these contributions becomes non-forfeitable.

Understanding Vesting and Cliff Vesting

Vesting refers to the point at which an employee gains a non-forfeitable right to employer contributions made to their retirement plan. This means the funds are legally theirs to keep, even if they leave the company. Until contributions are vested, they generally remain the property of the employer, subject to specific plan rules and legal frameworks like ERISA.

Cliff vesting is a schedule where an employee becomes 100% vested in employer contributions at a single, predetermined point in time. Unlike graded vesting, which allows for gradual ownership over several years, cliff vesting means there is no partial vesting beforehand.

The 3-Year Cliff Vesting Rule Explained

The 3-year cliff vesting rule dictates that an employee gains full ownership of employer contributions to their retirement plan only after completing three full years of service. This means that if an employee leaves their employment even one day before completing the full three years, they forfeit all employer contributions that have not yet vested. These forfeited funds typically revert to the plan to offset future employer contributions or reduce plan expenses, as permitted by IRS regulations.

For instance, if an employee starts on January 1, 2025, their employer contributions would become fully vested on January 1, 2028, assuming continuous employment. Should that employee terminate employment on December 31, 2027, all employer contributions would be forfeited.

Treatment of Benefits Under 3-Year Cliff Vesting

Under a 3-year cliff vesting schedule, the treatment of employer contributions depends entirely on an employee’s tenure. If an employee’s employment terminates before they complete three full years of service, any employer contributions made to their retirement account are forfeited. These unvested funds cannot be withdrawn or rolled over by the employee.

Conversely, if an employee remains with the company for three full years or longer, they retain 100% of all employer contributions made to their retirement plan. These fully vested funds become part of the employee’s retirement savings, available for distribution or rollover in accordance with the plan’s terms and applicable tax laws. It is important to note that employee contributions, such as those made to a 401(k) from an employee’s salary, are always immediately 100% vested and are never subject to any vesting schedule.