How Does a Vesting Schedule Work?

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A vesting schedule is set up by a company to determine when you'll be fully "vested," or acquire full ownership, of certain assets — most commonly retirement funds or stock options.

Your employer might be very generous with contributions to your retirement plan or to your stock option plan, but the money and any other benefits aren't truly yours until you've complied with the plan's vesting schedule. Up until that point, you still could forfeit your benefits.

What Exactly Is Vesting?

"Vesting" refers to your portion of ownership in the money that has been given to you as part of a retirement, stock option or another benefit plan. It's a somewhat confusing concept since even though you might see the money in your account, you still could forfeit that money (or another benefit) if you leave your job because you aren't vested in it yet.

To encourage your loyalty, employers frequently make their contributions to your retirement or stock option account subject to vesting schedules, which means they can dangle their contributions in front of you like a carrot — the more years you work, the more of their contributions you get to keep. If you leave, the funds revert to the company.

Vesting doesn't apply to any money you contribute yourself (it's your money, and you get to keep it if you leave the company). Whenever you make a contribution to your retirement plan at work, you are 100% vested in your own contributions. Vesting schedules apply only to the funds that companies contribute to on your behalf.

Vesting Schedules for Retirement Accounts

Vesting schedules come in three basic types:

  1. Immediate: Just as the name implies, employees with this type of vesting plan gain 100% ownership of their employer's matching money as soon as it lands in their accounts.
  2. Cliff: Cliff vesting plans transfer 100% ownership to the employee in one big chunk after a specific period of service (for example, one year). Workers have no right to any of their matching contributions if they leave before that period expires. But the day they reach the landmark date, they own it all. Federal law requires that cliff vesting schedules in qualified retirement plans such as a 401(k) or a 403(b) not exceed three years.
  3. Graded: Graded vesting gives employees gradually increasing ownership of matching contributions as their length of service increases, resulting in 100% ownership. For example, a five-year graded vesting schedule might grant 20% ownership after the first year, then 20% more each year until employees gain full ownership (100%) after five years. If the employee leaves before five years are up, she gets to keep only the percentage of the employer's matching contributions in which she is vested. Federal law sets a six-year maximum on graded vesting schedules in retirement plans.

Vesting Schedules for Stock Options

Stock options give employees the right to buy company stock at a set price, regardless of the stock's current market value. The hope is that the stock's market price will rise above the set price before the option is used, giving the employee a chance at a profit.

These plans can come with any of the basic forms of vesting.

In a cliff plan, for example, the employee gets access to all of the stock options on the same date. In a graded plan, employees are allowed to exercise only a portion of their options at a time.

If employees, for example, are granted options on 100 shares with a five-year cliff vesting schedule, they must work for the company for five more years before they can exercise any of the options to buy shares. In a five-year graded schedule, they might be able to buy 20 shares per year until they reach 100 shares in the fifth year.

Because most stock option grants are not part of an employee's retirement plan, their vesting schedules are not limited by the same federal rules that govern matching contributions.

Final Thoughts About Vesting

To reduce or even eliminate the possibility of forfeiting any employer matching contributions that you may be eligible for, it is important to learn and understand the vesting schedule and rules at your company. Be sure to review your most recent account statement, contact your human resources department, or check your benefits manual to learn more about any vesting schedules your retirement accounts may be subject to.