Tom has a qualified retirement plan with his employer that is currently considered to be 80% ?’vested’. How can this be interpreted?
20% ?of the funds are subject to taxes
80% ?of the funds are invested in a separate account
If Tom’s empioyment is terminated, 20% ?of the funds would be forfeited
If Tom’s employment is terminated, 80% ?of the funds would be forfeited
The correct answer and explanation is:
The correct interpretation is:
If Tom’s employment is terminated, 20% of the funds would be forfeited.
Explanation:
The term “vested” refers to the portion of a retirement plan (such as a 401(k) or pension) that a participant is entitled to retain, even if they leave the employer. Vesting schedules are typically used by employers to encourage employees to stay with the company for a longer period.
In this case, Tom is 80% vested in his retirement plan. This means that Tom has earned the right to keep 80% of the contributions made to his retirement account, whether or not he stays with the employer. The remaining 20% is considered “unvested,” meaning that if Tom were to leave the employer before becoming fully vested, he would forfeit the 20% of the funds that have not yet vested.
What this means practically:
- If Tom stays with the employer long enough to become fully vested (often after a certain number of years), he will own 100% of the funds in his retirement plan, both the employer contributions and the employee contributions.
- If Tom leaves the employer or is terminated before reaching full vesting, he would lose the unvested portion (in this case, 20%) of the employer’s contributions to his retirement account.
It’s important to note that the employee contributions are always vested. That is, regardless of how long Tom has worked for the employer, he would be entitled to keep the employee’s own contributions to the retirement plan, plus any earnings on them.
Why the other options are incorrect:
- “20% of the funds are subject to taxes”: Vesting does not refer to tax liability. All contributions to a retirement plan (whether vested or unvested) are generally subject to taxation at some point, typically when withdrawn.
- “80% of the funds are invested in a separate account”: Vesting pertains to the ownership of contributions, not where the funds are invested. The investment account may remain the same, but the ownership percentage changes.
- “If Tom’s employment is terminated, 80% of the funds would be forfeited”: This is incorrect because Tom would forfeit the unvested 20%, not 80%.
In summary, the key point is that “80% vested” means Tom can keep 80% of the funds, and if he leaves the company, he would forfeit the remaining 20%.