To determine whether these four vesting schedules comply with U.S. laws governing qualified retirement plans, we first need to understand what vesting means and how the rules differ between defined benefit and defined contribution plans.
Step 1: Understand Vesting
Vesting refers to an employee's legal right to keep retirement benefits earned through an employer's contributions, even after leaving the company.
For example, if an employee is 50% vested in $10,000 of employer-funded retirement benefits, the employee has a nonforfeitable right to $5,000 of those benefits.
There are two common types of vesting schedules:
Cliff Vesting: An employee becomes 100% vested after completing a specified number of years. Before that point, the employee may be 0% vested.
Graded Vesting: An employee gradually becomes vested over several years until reaching 100%.
U.S. federal law establishes minimum vesting standards under Section 411 of the Internal Revenue Code.
Step 2: Understand the Legal Requirements
For ordinary qualified defined benefit plans, employers generally have two options:
Option A: Five-Year Cliff Vesting
Employees must become 100% vested after no more than five years of service.
Option B: Three-to-Seven-Year Graded Vesting
The minimum vesting percentages are:
- After 3 years: 20%
- After 4 years: 40%
- After 5 years: 60%
- After 6 years: 80%
- After 7 years: 100%
For ordinary qualified defined contribution plans, employers generally have two options:
Option A: Three-Year Cliff Vesting
Employees must become 100% vested after no more than three years of service.
Option B: Two-to-Six-Year Graded Vesting
The minimum vesting percentages are:
- After 2 years: 20%
- After 3 years: 40%
- After 4 years: 60%
- After 5 years: 80%
- After 6 years: 100%
Employers may always offer faster vesting than these minimum requirements.
Step 3: Evaluate Each Proposed Schedule
1. Defined Benefit Plan: Full Vesting After 5 Years
Answer: YES, this complies.
A qualified defined benefit plan may use five-year cliff vesting.
Under this schedule, an employee can be 0% vested during the first four years and then become 100% vested upon completing five years of service.
Since the proposed schedule provides full vesting after five years, it satisfies the general legal requirement.
2. Defined Benefit Plan: 50% Vesting After 6 Years and 100% After 7 Years
Answer: NO, this does not comply.
A defined benefit plan using graded vesting must provide at least 80% vesting after six years.
The proposed schedule provides only 50% after six years, which is below the required minimum.
Furthermore, the graded schedule requires at least 20% after three years, 40% after four years, and 60% after five years.
Although the employee becomes fully vested after seven years, that alone does not make the schedule compliant.
To comply under the seven-year graded method, the employer must provide at least the required vesting percentages at each earlier milestone.
3. Defined Contribution Plan: 50% Vesting After 3 Years and 100% After 6 Years
Answer: NOT ENOUGH INFORMATION TO CONFIRM COMPLIANCE.
This schedule could comply with the six-year graded vesting rules, but only if it also satisfies the required minimum percentages in the other years.
Under the six-year graded schedule, an employee must be at least 40% vested after three years and 100% vested after six years.
The proposed 50% after three years exceeds the required 40%, and 100% after six years meets the final requirement.
However, the plan must also provide at least:
- 20% after 2 years
- 60% after 4 years
- 80% after 5 years
If those requirements are satisfied, the proposed schedule is legal.
If the employee remains at 50% through years four and five, the schedule would violate the minimum vesting requirements.
Therefore, the two percentages given are acceptable individually, but we need the complete schedule to determine whether the plan complies.
4. Defined Contribution Plan: Full Vesting After 2 Years
Answer: YES, this complies.
A qualified defined contribution plan generally allows three-year cliff vesting, meaning employees must become fully vested after no more than three years.
However, employers are allowed to provide more generous vesting schedules.
Since the proposed plan provides 100% vesting after only two years, it gives employees their full rights earlier than the law requires.
Therefore, this schedule complies.
Step 4: Final Answers
1. Defined benefit, 100% after 5 years: YES. Meets the five-year cliff vesting requirement.
2. Defined benefit, 50% after 6 years and 100% after 7 years: NO. The employee must be at least 80% vested after six years under the graded schedule.
3. Defined contribution, 50% after 3 years and 100% after 6 years: CONDITIONAL. The stated percentages meet the minimums for those years, but the schedule must also meet the minimum requirements for years two, four, and five.
4. Defined contribution, 100% after 2 years: YES. Faster vesting than the three-year cliff requirement is permitted.
Key Takeaway:
The law establishes the slowest permitted vesting schedules, not the fastest. Employers can always allow employees to become vested sooner.
The important point is that a plan must satisfy the minimum vesting requirements at every applicable service milestone, not simply provide 100% vesting by the final year.
These answers assume ordinary qualified retirement plans subject to the general federal vesting rules. Special plan categories, such as certain top-heavy or hybrid plans, may have additional requirements.
