By Shawn Dye, Trust Officer
A vesting schedule is an incentive program set up by an employer which, when it’s fully “vested,” gives the employee full ownership of a certain asset which is usually retirement funds or stock options. This is an employer’s way of getting an employee to stay with the company.
Vesting doesn’t apply to any money that you put towards your retirement account. Whenever you make a payment, such as your elective deferral or contributions, into your retirement plan at work you are 100% vested in your own contributions.
Your employer, vests their contributions, like their company match plan, as a way to get you to stay with the company. The longer you work at the company the more you are vested in the company’s contributions. If you leave before you are 100% vested, the company keeps the money you are not vested in even when it’s in your account. Knowing your retirement plan benefits is key when reviewing your benefits package, leaving before fully vested can leave substantial dollars behind.
Retirement Accounts and Their Vesting Schedules
There are three main types of vesting schedules:
- Immediate vesting: Employees with this type of vesting get 100 percent ownership of their employer’s money as soon as it is put in their accounts.
- Cliff vesting: Cliff vesting plans transfer 100 percent ownership to the employee in one big amount after a specific period of time. Employees have no right to any of the employer money if they leave before that period of time, but the day they reach the specific date, they own it all. These are generally no longer than three years.
- Graded vesting: Graded vesting gives employees gradually increasing ownership of matching contributions as time passes, eventually resulting in 100 percent ownership. For example, a five-year graded vesting schedule could give 20 percent ownership after the first year, then 20 percent more each year until 5 years which you would be 100 percent vested. Federal law states vesting schedules on retirement plans cannot be longer than six years.
Why Do Companies Need Vesting?
Companies should have vesting options for two main reasons:
- To give an incentive for their employees to stay. By offering additional stock options or pension money for staying longer with a company, it gives employees something to look forward to as time passes.
- To protect themselves from giving an incentive to bad hires. If a company hires someone and instead of creating a vesting schedule, gives each new employee access to stock options right away, they risk giving away money to people who will not stay for very long. A one-year cliff will protect companies from issuing stock to bad hires because it can often take a few months until it is recognized whether the new employee was a good choice for the company or not.
The Best Vesting Schedule
There is no single best vesting schedule. Companies need to assess the situation on a per-person basis. They will want to give different options to different new hires depending on how much they need that person, how much they want to incentivize that person, and how much it will cost the company if they leave.