Understanding the Basics of Vesting With Your Employer

Picture of stock certificate that indicates 100 shares
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Vesting Definition and Overview:

The concept of vesting is important to every employee of a firm offering benefits ranging from 401K matching contributions to restricted stock or stock options. Many employers offer these benefits as an incentive to join and/or remain with the firm. Many of these   benefits are subject to a vesting schedule.

You should understand the language and terms for vesting in your various employer contributions.

While some employer contributions are fully vested at the time they are provided, many others are subjected to time limits and or a graduate scale over time known as a vesting schedule. 

Note: this column is not intended to offer financial guidance. Please consult with a qualified financial or legal advisor for your own particular vesting question. 

Example-401K Contributions Reflect Immediate Vesting:

In our first example, your employer offers matching funds to your 401K deductions up to 10% of your total contributions. If you direct $10,000 in to your 401K this year, your employee will contribute an additional $1,000 (10%) in matching funds, with immediate vesting. The immediate vesting means that the contribution belongs to you in its entirety, although any withdrawals are subject to the IRS rules governing these plans. 

Example-Stock Grants Might Vest Immediately or Over Time:

Another example might be a firm that offers employees restricted stock grant on their hire date, with 100% vesting in the stock occurring on the employee's third anniversary date.

This form of vesting, cliff vesting, means that you have no claim on the items offered until the actual date is reached. If you leave the firm after two years, you would not be able to take or cash in any of your stock grant. 

An alternative to cliff vesting is graded or graduated vesting, governed by a vesting schedule.

In our example above of the restricted stock grant, a graded approach might suggest that 25% of the shares vest in years 1 and 2 (total 50%) and the remaining 50% on your third anniversary. If you were to leave the firm after your first year, you would have control of 25% of the shares and so forth. 

Example-Stock Option Grant Vesting:

The use of stock options is common in many privately held start-ups and technology firms. An option represents the right to acquire a share of stock at a particular price on or before a particular date, or, at a trigger event such as a change of control of the firm. This latter issue: change of control is a common trigger. Change of control is a fancy term for acquisition by another firm.

Consider a scenario where you have been granted 10,000 options with a strike price of $3.50 per share. If the terms of your stock option grant indicate that they fully vest at change of control and another firm acquires yours at $4.00 per share, your options immediately vest at the closing of the acquisition. In this case, you would have the right to buy the 10,000 shares at $3.50 each and immediately sell them for $4.00 each for a .50 cents per share profit. 

Example-Qualified Retirement Plan Vesting:

Many governmental, municipal and education jobs offer a qualified retirement plan that is governed by a vesting schedule based on your years of service.

As you accrue years of service, you increase your vesting percentage, with a maximum of 100% at a future anniversary date. If you leave the service of this organization prior to becoming fully vested, you will receive a future retirement benefit at some percentage of the total and not the total. 

The Bottom Line:

Pay close attention to the language surrounding vesting for any of the benefits from your employer that involve contributions. The vesting schedule may dictate your behavior, including remaining with the firm until an important anniversary date when some or all of the employer contributions become yours via vesting. 

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Updated by Art Petty