Vested Interests

The latest academic “dig” against 401(k) plans? Vesting schedules.

More specifically, firms with a combination of high turnover and vesting schedules, which means that workers are leaving behind employer contributions. Or, in the parlance of these new critics, being “robbed.” 

I stumbled across this “scandal” in an op-ed provocatively titled, “This giant pension scandal is hiding in plain sight,” which, in turn, drew from the points made in an academic paper titled, “Megacompany Employee Churn Meets 401(k) Vesting Schedules: A Sabotage on Workers’ Retirement Wealth.” The “scandal” is the legal vesting schedules under ERISA, notably the three-year variety in place at certain large, high-turnover employers.

The MarketWatch article[i]—and, more significantly, the academic paper[ii] upon which it is based, see the vesting schedule as part of some orchestrated conspiracy deliberately crafted to “rob”[iii] individuals of benefits/compensation to which they are entitled—ostensibly because they are incapable, and arguably in some cases, unable, to hold on to a job for a full three years. 

Indeed, Amazon draws most of the criticism here—not only for its three-year vesting schedule, but for the emphasis CEO Jeff Bezos has apparently placed on encouraging high turnover as a means of keeping perspectives “fresh.” That might work for Amazon’s business model (I suspect it matters more about the “who” than the “how often”), but in my experience, most employers find turnover to be costly, requiring the expense of finding replacements, training them, and then waiting for them to come up to speed. 

That said, a plan’s vesting schedule wouldn’t exactly seem to be “hidden.”[iv] Indeed, I have long found it to be an element that warrants a reasonable amount of discussion and specific focus during enrollment meetings, and for the very reason it exists: as an incentive to reward/retain/encourage longer-term workers (or at least it did before the shift in emphasis to automatic enrollment). I say longer term because the notion of long-term workers has shifted considerably since ERISA was passed in 1974, when the 10-year cliff vesting that was common among pension plans at the time reigned. Of course, the Tax Reform Act of 1986 established new, shorter minimum thresholds for vesting. Indeed, by the “norms” that were in place when the 401(k) came to prominence, 100% vesting within three years is “lightning fast.” 

So, what’s the beef? The argument put forward is that these vesting schedules create a “bait and switch” of sorts—the promise of an employer match kept just out of reach by a vesting schedule purposefully selected to kick in outside of the average worker’s tenure. And if that seems a tad too Machiavellian, there’s the overt actions that have been taken (particularly during COVID) by employers to reduce the workforce. 

That said, the paper speaks to some issues that are worth considering: the financial vulnerability of lower income workers, not to mention the financial literacy gaps there, and the retirement wealth gaps between men and women, as well as racial wealth gaps. We know these are real, but we also know that they are often remedied with access to a plan at work, assisted by plan design features like automatic enrollment and qualified default investment alternatives like target-date funds. 

Indeed, with regard to the latter, one of the two main recommendations of the paper (albeit with some editorializing) is to is to “collect data so we can truly assess the monster we are dealing with.”

However, the other main recommendation is problematic, if not unnecessary—specifically that we “prohibit megacompanies from using vesting schedules.” That, despite the fact that the paper itself cites data both from Vanguard and the Plan Sponsor Council of America which says that roughly half of the nation’s largest employers already provide immediate 100% vesting. 

Does a vesting schedule provide an incentive to “stick around”? Arguably it does (though it’s probably not going to trump job criteria like location), but in the words of the paper’s author, “…using vesting schedules to reduce turnover only works if employees understand the vesting policies.”

Ultimately, I’d argue that the issue to address isn’t vesting. After all, those who have access to a retirement plan, regardless of vesting, have a real edge on those who don’t. And let’s not kid ourselves—there are plenty of valid reasons, particularly amid today’s so-called “Great Resignation,” to leverage benefit programs to attract and retain talent. 

Certainly, the company match can—and should—be a factor in that arsenal, and I’d argue that the employer has a “vested” interest in that outcome—and that workers, properly informed and educated to appreciate that benefit, do as well.