Jul 27, 2009


The vesting provisions of a plan determine the amount of benefit that a participant is entitled to receive upon terminating employment prior to retirement.

In a defined-contribution plan, the termination benefit is the vested portion of the participant's account balance. In defined-contribution plans, particularly profit-sharing plans, the account balance usually is distributed to the participant in full at termination of employment. It is technically possible to defer the distribution to the participant's normal retirement date, but this is rarely done in defined-contribution plans because it causes additional expense to the plan with little or no corresponding benefit to the employer or the plan. However, the plan may give the participant the option to leave the funds on deposit in the plan for withdrawal at a later date, to allow the participant to take advantage of the tax-deferred investment medium afforded by the plan, with a possible loss of favorable income tax treatment on the later plan distribution.

For a defined-benefit plan, the benefit on termination of employment is more complicated. The benefit will be the vested accrued benefit as of the date of termination, determined under the vesting and the accrual rules already described. Use the same example as in the discussion of the fractional accrued-benefit rule, again supposing that an employee terminates employment at age 55 after 20 years of service and the plan's normal retirement age is 65. If the participant is fully vested and the accrued benefit is $8,000 as discussed in the earlier example, an annuity of $8,000 per year will be payable beginning at age 65.

To make sure that terminated participants actually receive deferred vested benefits at retirement, which may be many years after termination, the employer must report all deferred vested benefits of terminated participants to the Social Security Administration, which then can inform retirees of their rights to benefits from plans of former employers. This reporting is done on the Form 5500 series.

In some cases, the deferred vested benefit may be such a small amount that keeping track of it until the participant's retirement is merely a nuisance for both employer and employee. The employer can cash-out a distribution—that is, pay cash to the employee in lieu of the deferred vested benefit—without the employee's consent, so long as the entire benefit is distributed and the employer portion of the benefit so distributed does not exceed $5,000. The involuntary cashout must be within one year of termination of participation in the plan; the plan must have a provision permitting the employee to repay the cashout to the plan if the employee was not fully vested at the time of termination, in case the employee should resume participation in the plan. A cashout of a benefit that exceeds the $5,000 limit can be made, but only with the consent of the employee.


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