Free Money? 401(k)s, Vesting, and Unemployment

This paper analyzes the effects of employment risk and vesting rules on the substitution between 401(k)s and conventional savings. Nearly two-thirds of 401(k) plans include vesting rules, which stipulate a partial or complete forfeiture of employer-matched contributions in the event of a job loss that occurs before a service requirement is met. We characterize this risk by simulating a stochastic dynamic programming model that incorporates vesting and key institutional features of the 401(k). We examine the impact of vesting on participation in the 401(k), saving both inside and outside the plan, aggregate saving and welfare. We find that participation—primarily of younger workers—falls with longer vesting durations. This drop in participation is mirrored by a reduction in the substitution of 401(k) plans as a buffer against unemployment risk. The net effect on aggregate saving is small, and the welfare cost is modest. “If it’s a matched plan, your employer is helping you become rich by adding a contribution to your account. Free Money!” —Wallstreetcity.com