A vesting schedule is an innovative incentive program that grants employees benefits, such as stock options or retirement funds, after they have fulfilled a specified term of employment. This powerful tool helps employers retain top talent and maintain company loyalty.
Key Takeaways
- When an employee is vested in employer-matching retirement funds or stock options, they gain nonforfeitable rights to those assets.
- Vesting often increases progressively over a set number of years, culminating in full ownership.
- Common vesting schedules range from three to five years.
Understanding Vesting
In retirement plans, vesting gradually gives employees rights to employer-provided assets, incentivizing them to stay and perform well. The vesting schedule determines when employees gain full ownership.
Typically, these nonforfeitable rights accrue based on the employee’s service duration. For instance, in a 401(k) company match, matching funds take years to vest, requiring employees to remain with the company to be eligible.
In stock bonuses, vesting serves as a key retention strategy. Imagine an employee receiving 100 restricted stock units as part of an annual bonus: the stock vests in installments over five years (e.g., 25 units per year after the first year). If the employee leaves after three years, only 50 units vest, with the remainder forfeited.
For certain benefits like salary-deferral contributions and SEP or SIMPLE employer contributions, vesting occurs immediately. Employer contributions to a 401(k) may either vest immediately or follow a vesting schedule—such as cliff vesting (100% ownership after a certain period) or graded vesting (gradual percentage ownership).
Traditional pension plans might follow a five-year cliff vesting or a three- to seven-year graded vesting schedule. However, being fully vested doesn’t permit immediate liquidation of funds. Employees must typically meet retirement age criteria to withdraw without penalties.
Special Considerations
Vesting isn’t limited to employee benefits; it also applies to wills and bequests, often incorporating waiting periods to finalize inheritances and mitigate conflicts or double taxation issues that may arise from overlapping deaths.
Startup companies frequently offer common stock grants or employee stock options to not only employees but also service providers, vendors, board members, and other parties as part of their compensation. These usually come with a vesting period (commonly three to five years) to bolster employees’ commitment to the company’s success and future.
Related Terms: restricted stock units, 401(k), pension plans, SEP, SIMPLE.
References
- Internal Revenue Service. “Retirement Topics—Vesting”.
