The Effects of 401(k) Vesting Schedules—in Numbers
abstract. Many Americans terminate employment, voluntarily or involuntarily, prior to vesting in their 401(k) plans. This costs them a lot of money; it also saves companies a lot of money. Vesting schedules used by some 401(k) plans cause plan participants to forfeit significant portions of their compensation—employer contributions made on their behalf—that should be increasing their retirement savings. This money is recycled by such plans to offset their employer contribution obligations and other costs.
We analyzed data from Form 5500s to identify trends in and implications of vesting schedule use by 408 single-employer 401(k) plans over the five-year period of 2018-2022. Our findings show that the number of participants terminated before full vesting is growing rapidly. Further, we analyzed data from Form 5500s for 909 single-employer 401(k) plans for 2022. We found that 1.8 million plan participants forfeited compensation because they terminated employment (voluntarily or involuntarily) without being fully vested in their employer plan contributions. Amazon’s and Home Depot’s 401(k) plans have had the most affected participants for the past three years. Additionally, in the 909 plans we analyzed, we found that forfeitures used in 2022 amounted to a staggering $1.5 billion, most of which was used to reduce an employer’s contribution obligation. Our findings highlight the magnitude of the implications of 401(k) vesting schedule use and identify key companies whose plans have the most affected participants and the highest amounts of forfeitures at their disposal.
introduction
A majority of Americans do not have enough money saved to support themselves through retirement.1 Accumulating retirement savings is no easy task: Americans are expected to set aside money for retirement while many struggle to cover high, inflation-induced costs for food, housing, transportation, healthcare, and more.2 The difficulty of saving for retirement is a problem not only for savers and their families, but also for federal and state governments and their taxpayers.3
Employers have tax incentives to assist their employees with saving for retirement. As a result, many employers offer retirement savings vehicles such as 401(k) plans and contribute vast sums of money to their plans annually. But not all 401(k) plans are created equal. Plan features can vary significantly: participants who work for some companies have lesser benefits than others, and some also forfeit such compensation upon termination of employment. Our research primarily focused on one specific 401(k) plan feature—vesting schedules—and the resulting forfeitures. This Essay’s purpose is to summarize and release our data together with our findings. Future articles will discuss the policy implications of our findings.
When creating a 401(k) plan, an employer chooses whether to vest its contributions immediately or utilize a vesting schedule. Employers view this choice differently. Some employers do not use a vesting schedule, likely because they want to offer better benefits to attract and retain workers. Perhaps offering better retirement benefits is also part of the company’s culture. Other employers—particularly those who experience high turnover—use vesting schedules to incentivize workers to stay longer, in the hope that workers will stay at least long enough to vest in their employer contributions.4 Employee retention is often paired with other financial advantages as well. When a plan participant’s employment ends prior to vesting, the plan must use the forfeited funds, and this recycling generates savings for employers as well.5
Employer savings achieved by vesting schedules certainly benefit employers, but vesting schedules often become mechanisms that negatively foster wealth redistribution. Forfeited employer contributions are removed from participant accounts—which are commonly held by vulnerable groups that traditionally struggle to accumulate retirement wealth—and are returned to the plan trust. In turn, plan administrators can redistribute forfeited funds to remaining participants who likely hold higher-paid positions with drastically diminished turnover rates. Retirement savings are essentially transferred from workers that will need those funds when ready to retire to workers that can much more easily accumulate retirement wealth. Over the past three years, the Amazon 401(k) Plan and the Home Depot Futurebuilder Plan have seen the highest numbers of participants terminate employment without being fully vested. As such, we emphasize throughout how Amazon’s and Home Depot’s plan numbers compare to others.
In this Essay, we present several figures and tables that provide a glimpse into the implications of vesting schedule usage. At times, we refer to companies rather than their 401(k) plans for succinctness. When reference is made to the company, it incorporates its 401(k) plan. For instance, we sometimes refer to the Home Depot Futurebuilder plan as Home Depot or Home Depot’s 401(k) plan for short. Additionally, the term “affected participants” refers to participants who terminated without being fully vested in their account balances. The term “terminated” means ceased employment, whether voluntarily or involuntarily.
In our study, we share data on the number of participants who have terminated without being fully vested in 909 single-employer qualified 401(k) plans for 2022.6 We also highlight the top ten companies with the greatest numbers of these participants over the past five years. We compiled data that show the astronomical amounts of money that participants forfeit and what plans do with this money. We analyzed this data both cumulatively and individually to identify the plans that used the largest forfeiture dollar amounts in 2022. We then compared competitor companies and found that companies’ plans that use vesting schedules have competitors whose plans immediately vest their participants and hence have no forfeitures to use. Companies that assist other employers in forming, amending, or administering 401(k) plans, while also using vesting schedules themselves, were closely examined in comparison to competitors that offer immediate vesting for company contributions. Lastly, we compiled a nonexhaustive list of plans that changed from immediate vesting to a vesting schedule.
In the United States, workers rely heavily on money that employers contribute to supplement their retirement savings. Our findings suggest that the problems with vesting schedules together with their resulting forfeitures loom large and in practice run afoul of this reliance. Permitting the use of vesting schedules for employer contributions minimizes workers’ ability to save because they forfeit the money that employers contribute on their behalf to the extent not yet vested. Once forfeited, a majority of the plans we studied use this money in a manner that allows employers to experience savings. Indeed, most of this money is used to offset future employer contributions. Since matching contributions—a prevalent type of employer contribution—are contingent upon salary deferrals, it is possible that higher-paid participants receive more money in employer contributions.7 And vesting schedule use exacerbates the ability of the more vulnerable members of society to accumulate retirement wealth.8
i. how vesting schedules and forfeitures work9
Employees, as participants in a company’s retirement plan, are able to make direct contributions to their 401(k) plans by contributing a certain percentage of theirsalary.10 These direct contributions made by participants are known as “salary deferrals.”11 Participants are 100% vested in funds they contribute as salary deferrals.12 But employer contributions are either immediately vested or can be subject to one of two types of vesting schedules: cliff vesting or graded vesting.13 Cliff vesting means that the plan participant will vest 100% after a certain number of years of service (usually defined as 1,000 hours in a year) but will have no vested balance before that is achieved.14 This means that the participant is either entitled to all of the employer contributions or none of them.15
Unlike cliff vesting, graded vesting occurs incrementally over a number of years.16 The Internal Revenue Code (IRC) and accompanying regulations outline the two minimum vesting schedules that serve as baselines for employer contributions to 401(k) plans: three-year cliff and six-year graded.17
In three-year cliff vesting, the participant vests 100% in year three after achieving 1,000 hours of service for three consecutive years.18
Instead of using a vesting schedule, a plan can provide for immediate vesting, or it can adopt a variation of the above, so long as the schedule is at least as favorable to the participants as one of the two shown above.20 For instance, a plan can have a one-year cliff, which is better for the participant than a three-year cliff, or a plan can be four-year graded, which is better for the participant than six-year graded.
When a participant’s employment ends, voluntarily or involuntarily, prior to vesting, they forfeit the money that is not yet vested. Because money that gets contributed into the plan becomes a plan trust asset that must be held in a trust fund to ensure it is used “solely to benefit the participants and their beneficiaries,”21 it cannot be returned to the employer—that is, it must be used for plan purposes. A plan document governs how the plan may use the forfeited funds. The options for forfeited-fund use are provided by a 1984 Revenue Ruling and Treasury Regulations.22 Forfeited funds may be used (1) to reduce future employer contributions including corrective distributions; (2) to pay reasonable administrative expenses; (3) to provide additional contributions to current participants; and/or (4) to restore previously forfeited participant accounts.23 Many plans allow for a combination of these uses, and the plan administrator can choose what is best in any given year.24 Some plans provide a hierarchy for how forfeitures must be used.25
Forfeiture rules directly allow the employer to recycle monies it has contributed to its 401(k) plan, thereby reducing the requirement to continue to fund employer contributions and other related expenses with new money.26 These rules lead to negative effects on retirement savings for more transient low- and middle-income workers while subsequently bolstering the retirement of the highest-paid employees occupying low-turnover positions.27 When companies know they have high turnover and use a vesting schedule, they “flout[] the historical employee retention rationale underlying vesting” by double dipping and using forfeited funds to reduce their own costs.28 A significant number of those that fill these high-turnover positions are low-paid workers and people of color—groups that historically lack advantages such as generational wealth and greater financial literacy to assist in retirement saving.29 These workers thus lose out on retirement savings in far higher numbers and rates than their higher-paid coworkers and supervisors.30
Additionally, when the plan administrator chooses the option to distribute the forfeitures among current participants (option three above), they are redistributing contributions that the employer likely made on behalf of lower-paid, high-turnover employees to employees who do not turn over and are likely paid more.31 These higher-paid, low-turnover individuals also retain a substantially higher balance of retirement benefits than lower-income individuals and their respective households.32 Such reallocations create a disparity because they are generally based on the participants’ salary deferral percentage.33 Higher-paid employees generally are more loyal and save more by contributing higher percentages of their pay to their 401(k) plans.34
Fundamentally, accumulating retirement savings is difficult for many people. Every potential source of retirement savings could affect the financial security of an individual once they are no longer able to work. Retirement insecurity and an uncertain financial future represent the dangerous reality faced by millions of Americans.35 Companies who use vesting schedules—mechanisms that foster wealth redistribution and eliminate retirement savings that individuals may desperately need in the future—exacerbate the daily struggles that Americans already experience when attempting to accumulate retirement wealth.
ii. form 5500, methods, and limitations
A. Form 5500
Form 5500 is an Annual Report required of 401(k) and other plans covered by the Employee Retirement Income Security Act.36 A publicly accessible disclosure document, it is used by the U.S. Department of Labor (DoL), Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corporation to ensure compliance.37 Form 5500 is also “a source of information and data for use by other Federal agencies, Congress, and the private sector in assessing employee benefit, tax, and economic trends and policies.”38 Information is provided on Form 5500 as numeric line items and in text form. We relied on Form 5500s for our research.
B. Methods
Song Yi and Lynn Johnson of the DoL Employee Benefits Security Administration Office of Research and Analysis provided us with a compilation of publicly available data from Form 5500 filings for single-employer plans with the most affected participants over a period of five years. Their data extraction method was to determine generally whether a plan was a 401(k) plan based on whether the “TYPE_PENSION_BNFT_CODE” variable reported use of the “2J” code in the Form 5500 filing.39 They provided us with 1,000 of the top Form 5500 filings based on line item 6(h). Line item 6(h) represents the number of participants who terminated prior to being fully vested during the applicable plan year.40
Data we used in our analyses from DoL’s Form 5500 dataset were: line 6(h) (SEP_PARTCP_PARTL_VSTD_CNT); the plan name (PLAN_NAME); the North American Industry Classification System (NAICS) code (BUSINESS_CODE); the plan sponsor name (SPONSOR_DFE_NAME); line 6(a)(2), the number of participants at end of year (TOT_ACTIVE_PARTCP_CNT); and the plan year end date (FORM _TAX_PRD).41
The DoL-provided dataset had occasional instances where a plan was listed more than once in the same year, likely due to an amended filing. Therefore, we did not have data for 1,000 distinct plans we could use. After data were compiled into Excel spreadsheets, data cleaning and analyses were performed in R version 4.2.2. Duplicate entries were identified as having the same year and plan name or sponsor name and were subsequently removed.42 Plans with data present on the DoL-provided dataset for all five years were identified as plans having five instances of the same plan name or sponsor in the dataset (n=408).43 This subdataset was then visually inspected, and instances of a plan or sponsor name changing slightly over time were identified and conformed (e.g., “Inc.” to “LLC”) for ease of analysis. The first two numbers of NAICS codes were used to define industry sectors as described by the U.S. Bureau of Labor Statistics.44
For 2022, the dataset includes plans that had affected participants ranging from 289,820 (the highest) to 453, as indicated on line 6(h). While 453 does not represent the absolute lowest number of affected participants found in all existing 2022 Form 5500 filings, it does represent the lowest number in the 1,000 plans we were given.
For each of the 909 plans in our 2022 dataset, we manually extracted data from the Form 5500 text that reflected employer contribution types, vesting schedules used, forfeiture amounts, and forfeiture use. Manual extraction was necessary because there are no line items for information pertaining to these characteristics in Form 5500.45
Ultimately, the dataset gives future researchers a uniquely comprehensive look into retirement plans. First, the dataset includes data that are publicly accessible, ensuring that data are collected regardless of the plan administrator.46 Additionally, because Form 5500 reporting is mandatory, the dataset is inclusive of all businesses and is not reliant on eliciting responses through surveys. These two important considerations ensure that the dataset presents an accurate representation of the administration of retirement plans broadly.
C. Limitations: Forfeiture Data
In our research, we observed that a majority of plans reported clear and accurate forfeiture data. However, some plans reported inconsistent and inconclusive information relative to the amount of forfeitures and forfeiture use. In those cases, we were unable to extract reliable forfeiture data because plan descriptions (1) only reported a total balance of forfeitures on the last day of a plan year; (2) only reported the total number of forfeitures created in the plan year; (3) only provided information pertaining to how forfeitures could be used according to plan provisions; or (4) were precluded from public disclosure by DoL.
Remaining limitations stemmed from imprecise language found in forfeiture disclosures. One such limitation was our frequent inability to determine whether forfeitures were used to reduce “employer” or “company” contributions that were obligatory, discretionary, or both.47 We note that at least a portion of the contributions that forfeitures were used to reduce in 2022 was discretionary rather than obligatory.48 Another limitation was the use of terms like “approximately” or “immaterial” in forfeiture disclosures.49 Our research exacted these approximate numbers for analyses and regarded any amount labeled immaterial as having no value. As a result, the numbers provided throughout this Essay reflect the most accurate findings that could be exacted from forfeiture disclosures found in Form 5500 submissions. Our discussion in Part IV provides further information on these limitations and make suggestions for amending Form 5500.
iii. insights from original data analysis of form 5500s
A. Rising Numbers of Affected Participants: Amazon, Home Depot, and the Trade, Transportation, and Utilities Sector Lead the Pack
1. A Rapid Increase in Affected Participants50
The total number of affected participants is increasing rapidly. Figure 1 shows the number of affected participants from 2018-2022 with varying numbers of plans (n-values). For 2022, 909 plans were analyzed, showing over 1.87 million affected participants; for 2018, 886 plans were analyzed, showing over 1.22 million affected participants.51 This analysis shows that large numbers of people forfeited funds, losing compensation that could be increasing their retirement savings.
figure 1. number of affected participants over five years (n=number of plans)
Figure 2 shows our analysis of 408 plans that were consistent across all five years. Using this grouping, there were over 1.36 million affected participants in 2022.52 This subset holds the same trend as the full dataset used in Figure 1. This trend is not solely attributable to Amazon; however, as Amazon has grown, so has the number of affected participants in its 401(k) plan.53
It is important to remember that these numbers reflect individuals who participated in the companies’ 401(k) plans but did not receive the benefit of their employer contributions—at least not fully. When plans use a three-year cliff vesting schedule, and a participant has terminated prior to completing three years of service, they receive none of their employer contributions. When plans use a graded schedule, and a participant has terminated before working the number of years required to vest fully, they receive only a percentage of their employer contributions.
figure 2. number of affected participants over five years (n=408 plans)
2. Amazon’s and Home Depot’s 401(k) Plans
Amazon’s and Home Depot’s 401(k) plans have by far the most affected participants in the past three years. Tables 1-5 show the top ten plans based on numbers of affected participants. As shown, Amazon’s plan jumped to the top spot in 2020 and has retained this position throughout 2021 and 2022.54 Home Depot’s plan has been either first or second on the lists for the past five years.55 This signals that large numbers of Amazon’s and Home Depot’s workers are missing out on a valuable benefit—additional retirement savings.
The number of affected participants can show which of the companies using vesting schedules in their 401(k) plans churn more employees. If one assumes Amazon’s warehouse business is the part that incurs the highest turnover, one can infer that those in lower socioeconomic positions—warehouse workers—make up a significant portion of the affected group in their plans. Amazon’s warehouse (“Field & Customer Support”) demographics for 2022 reveal that those workers identify as 32.1% Black, 28.5% Latino/a/x, 27.8% White, 9.8% Asian, 2.1% Native American, 1.6% Multiracial, and 0.6% Other.56
A majority of the top ten plans with the most affected participants remained consistent over the five-year period. The six plans that appear in all five years are Amazon’s 401(k) Plan; The Home Depot Futurebuilder; HCA 401(k) Plan; J.C. Penney Corporation Inc. Safe Harbor 401(k) Savings Plan; Charter Communications Inc. 401(k) Savings Plan; and Sodexo 401(k) Employees Retirement Savings Plan and Trust.57
The data indicate that the number of affected participants who have forfeited retirement benefits in the top ten plans has more than doubled from 2018 to 2022.58 The percentage of affected participants has also increased from less than a quarter to over a third of the total participants in the plans that we analyzed. Broken down by year, the data conveyed the following:
-
·
In 2018, the number of affected
participants from the top ten plans is 282,855,
which represented 23% of the 886
plans we analyzed.
·
In 2019, the number of affected
participants from the top ten plans is 303,804,
which represented over 23% of the
884 plans we analyzed.
·
In 2020, the number of affected
participants from the top ten plans is 329,642,
which represented nearly 26% of the
870 plans we analyzed.
·
In 2021, the number of affected
participants from the top ten plans is 535,574,
which represented 32% of the 863
plans we analyzed.
table 1. top ten plans with most affected participants in 2022
table 2. top ten plans with most affected participants in 2021