A plan must meet certain minimum standards regarding the non-forfeitability of retirement accounts or accrued benefits.¹ This is determined by the plan’s vesting schedule. Defined benefit plans that are top heavy may be subject to an accelerated vesting schedule (Q 3922).

Five basic requirements generally apply to the vesting of participant benefits:

(1) full vesting at the plan’s retirement age,

(2) full vesting at the termination of the plan,

(3) full vesting of salary deferrals and employee contributions,

(4) a plan must meet either the cliff vesting or the scheduled vesting requirements under all other circumstances, and

(5) a plan amendment may not reduce a participant’s vested benefit.

An employee’s right to normal retirement benefits must be non-forfeitable on the attainment of normal retirement age.² Normal retirement age is defined in the IRC as the earlier of normal retirement age under the plan, or the later of age 65 or the fifth anniversary of the date participation commenced.³ Plans may, under certain circumstances, define normal retirement age as the earlier of normal retirement age as defined above or the age at which the participant completes the number of years of service (not less than 30) required by the plan.⁴ An employee’s rights in accrued benefits derived from the employee’s own contributions must be non-forfeitable.⁵

Vesting can be determined based on all accounts in the plan or may provide separate schedules for various types of accounts (e.g., match, deferral, profit sharing account). It generally is not permissible for one group of employees to be subject to one vesting schedule and another group subject to another schedule in the same plan.⁶ Where there is a pattern of abuse relating to vesting or changes in vesting (such as dismissing employees to prevent vesting), a more rapid rate of vesting may be required.⁷ The determination of whether there is a pattern of abuse depends solely on the facts and circumstances in each case.⁸

Specific vesting requirements that apply to defined benefit plans are discussed in Q 3871, and those applicable to defined contribution plans and certain top heavy defined benefit plans are discussed in Q 3872.

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Planning Point: Firing an employee to prevent vesting is also a violation of ERISA Section 510.

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Rate of Benefit Accruals or Allocations

If an employee’s benefit accruals or allocations (in the case of a defined contribution plan) cease, or if the rate of an employee’s benefit accrual or rate of allocation is reduced because of the attainment of any age, the plan will not satisfy the IRC’s vesting requirements.⁹ Special rules apply to reductions of benefit accruals in statutory hybrid plans effective plan years beginning on or after January 1, 2016.¹⁰

Definitions

“Normal retirement benefit” means the employee’s accrued benefit without regard to whether it is vested; thus, a plan cannot qualify if it provides no retirement benefits for employees who reach normal retirement age with fewer than five years of vesting service.¹¹ A plan that provides that an employee’s right to normal retirement benefits becomes non-forfeitable on the normal retirement date will fail to meet this requirement if the normal retirement date, as defined in the plan, may occur after the employee’s “normal retirement age” as defined in IRC Section 411 (e.g., where normal retirement date is defined in the plan to be the first day of the calendar month following the employee’s 65h birthday).¹²

“Accrued benefit” means, in the case of a defined benefit plan, the employee’s accrued benefit determined under the plan (Q 3716) expressed in the form of an annual benefit commencing at normal retirement age, or, in the case of any other kind of plan, the balance of the employee’s account.¹³ The accrued benefit of a participant generally may not be decreased by an amendment to the plan (Q 3876).

The term “year of service” generally means a 12 month period, typically the plan year, designated by the plan during which an employee has worked at least 1,000 hours (although that amount may be less). It also may be measured using an elapsed time method.¹⁴ All years of an employee’s service with the employer are taken into account for purposes of computing the non-forfeitable percentages specified above except those years specifically excluded in IRC Section 411(a).¹⁵ That section permits a plan to exclude service before age 18, and service prior to the effective date of the plan.

A right to an accrued benefit is considered to be non-forfeitable at a particular time if, at that time and thereafter, it is an unconditional right.¹⁶ Some courts have made a distinction between vesting and non-forfeitability. A participant is vested when he or she has an immediate, fixed right of present or future enjoyment of his or her accrued benefit. A plan may provide that a vested benefit will be forfeited in whole or in part if, for example, the participant terminates his or her employment and goes to work for a competitor of the employer or commits a crime against the employer.¹⁷ Thus, for example, a participant could be offered immediate 100 percent vesting of his or her benefit under a plan, but the benefit could be forfeitable (to the extent the benefit would not be vested under the closest IRC and ERISA schedules) if the employee commits certain forbidden acts. These are called “bad boy” clauses. Several circuit courts have held that forfeiture provisions are enforceable only to the extent that the accrued benefit forfeited by commission of the forbidden act is in excess of the non-forfeitable accrued benefit derived from employer contributions to which the participant was entitled under the nearest equivalent ERISA vesting schedule at the time the forfeiture occurred.¹⁸ The temporary regulations generally follow this reasoning.¹⁹

A defined benefit plan (Q 3715) that is not structured as a cash balance plan or that is not top heavy, as determined under IRC Section 416, must provide vesting based on credited service that is at least as favorable as one of two schedules (IRC Section 411(a)(1)):

(1) Under the five year cliff vesting schedule, an employee who has at least five years of credited service must have a nonforfeitable right to 100 percent of his or her accrued benefit derived from employer contributions.¹

(2) Under the three to seven year vesting schedule, an employee who has completed at least three years of credited service must have a nonforfeitable right to at least the following percentages of his or her accrued benefit derived from employer contributions: 20 percent after three years of service, 40 percent after four years of service, 60 percent after five years of service, 80 percent after six years of service, and 100 percent after seven years of service.²

A defined benefit plan structured as a cash balance plan must provide full vesting at the completion of three years of creditable service.

All defined contribution plans and top-heavy defined benefit plans are required to provide vesting based on a participant’s credited years of service that are at least as favorable as one of the following two schedules (Q 3725):

(1) Under the three year cliff vesting schedule, an employee who has at least three years of service must have a non-forfeitable right to 100 percent of his or her accrued benefit derived from employer contributions.¹

(2) Under the two to six year vesting schedule, an employee who has completed at least two years of service must have a non-forfeitable right to at least the following percentages of his or her accrued benefit derived from employer contributions: 20 percent after two years of service, 40 percent after three years of service, 60 percent after four years of service, 80 percent after five years of service, and 100 percent after six years of service.²

Generally, yes. If a plan’s vesting schedule is modified by a plan amendment, the general rule is that the plan does not comply with the vesting schedule requirement if the nonforfeitable percentage of the percentage of the accrued benefit derived from employer contributions, (determined as of the later of the date the amendment was adopted or became effective) of any plan participant is less than the nonforfeitable percentage computed without regard to the amendment. In addition, a plan amendment that changes the vesting schedule must permit each participant with at least three years of service to elect to have the non-forfeitable percentage computed under the plan without regard to the amendment.¹

Editor’s Note: The IRS has released new proposed regulations to clarify the permitted uses of forfeitures in defined contribution plans.  Under the new proposed regulations, defined contribution plans will be entitled to use plan forfeitures to (1) pay the plan’s administrative expenses, (2) reduce employer contributions under the plan, or (3) increase benefits for other participants if the plan terms permit this action.  Plans will be required to use all forfeitures no later than 12 months after the end of the plan year in which the forfeiture occurred.  A transition rule will apply so that a forfeiture incurred during a plan year beginning before January 1, 2024 will be treated as having occurred in the first plan year that begins on or after January 1, 2024.  Plans should review their documents to ensure that one or more of these permitted uses of forfeitures is permitted in the written plan documents.

The vesting rules do not require a plan to provide a preretirement death benefit aside from the employee’s accrued benefit derived from his or her own contributions. The IRC provides that, “A right to an accrued benefit derived from employer contributions shall not be treated as forfeitable solely because the plan provides that it is not payable if the participant dies,” except as required by the survivor annuity provisions (Q 3882).¹A reversion to the employer of contributions made under a mistake of fact or a mistake as to deductibility is not a forfeiture even if it results in adjustment of an entirely or partially nonforfeitable account, provided the return is limited to an amount that does not reduce a participant’s balance below what it would have been had the mistaken amount not been contributed.²

Without violating the nonforfeitability rules, a plan may provide that payment of benefits to a retired employee is suspended for any period during which the retired employee resumes active employment with the employer who maintains the plan or, in the case of a multiemployer plan, in the same industry, the same trade or craft, and the same geographic area covered by the plan as when his or her benefits commenced.³ The provision must be carefully drafted and administered to comply with applicable regulations and rulings.⁴

Editor’s Note: The COVID-19 pandemic created a situation where many employers faced partial plan terminations due to furloughs and layoffs. Congress provided temporary relief in some situations. Under the CARES Act, employees who were rehired by the end of 2020 were not counted in determining whether a partial plan termination had taken place.  Under the Consolidated Appropriations Act of 2021, plans were not treated as having been terminated if the number of active participants covered by the plan on March 31, 2021 was at least 80 percent of the number covered by the plan on March 13, 2020. The relief was available for any plan if any portion of the plan year included the period beginning March 13, 2020 and ending March 31, 2021.A plan must provide that on its termination or partial termination (or, in the case of a profit sharing plan, also on complete discontinuance of contributions), benefits accrued to the date of termination or to the date of discontinuance of contributions become nonforfeitable to the extent funded at such date.¹

The merger or conversion of a money purchase pension plan into a profit sharing plan generally does not result in a partial termination and accelerated vesting provided that all employees who are covered by the money purchase plan remain covered under the continuing profit sharing plan, the money purchase plan assets and liabilities retain their characterization under the profit sharing plan, and employees vest in the profit sharing plan under the same vesting schedule that existed under the money purchase plan.²

A complete discontinuance may be deemed to have occurred when amounts contributed by an employer are not substantial enough to reflect an intent to continue to maintain the plan. Failure to make substantial and recurring contributions generally is regarded as a discontinuance of the plan. If this occurs solely because there are no current or accumulated profits, it may not constitute discontinuance as long as it is reasonable to expect contributions in future years.³

Whether partial termination or complete discontinuance has occurred depends on all the facts and circumstances. If a partial termination occurs, the vesting requirements that result from a partial termination apply only to the part of the plan that is terminated. Thus, a plan provision that states discontinuance will occur only when the ratio of aggregate contributions to compensation falls below a predetermined figure does not meet this qualification requirement and would need to be removed from the document.⁴

Vesting requirements are not violated by a provision requiring pension payments to be reduced, or offset, by amounts received by the pensioner under a state workers’ compensation law. Furthermore, state laws prohibiting offset of retirement benefits by workers’ compensation benefits are preempted by ERISA.¹Vesting requirements were not violated where, under a severance pay plan, an employee’s severance pay was reduced by the actuarial value, at discharge, of the employee’s vested interest in a qualified pension plan. The severance pay plan was not a pension plan under ERISA subject to vesting standards.²

A pension plan whose benefits may be offset by benefits under a profit sharing plan will be considered to satisfy benefit accrual requirements if the accrued benefit, determined without regard to the offset, satisfies the vesting requirements and the offset is equal to the vested portion of the account balance in the profit sharing plan (or to a specified portion of the vested account balance).³