Investor Basics: What Is Vesting?

Vesting is a company policy that specifies when an employee fully controls retirement plan contributions made to his or her account by the employer.

Employers want to keep you as long as they can. As part of an overall retention plan, companies often contribute matching funds to retirement plans starting soon after hiring but delay your ability to control those contributions until some period of time has passed, usually several years.

The most common area where vesting is used is in 401(k) retirement savings plans.

Vesting there refers to the length of time an employee has worked for the employer, in direct relation to employer-paid contributions into the retirement plan.

First, it’s important to note that an employee’s own personal contributions to a retirement plan are always 100% vested.

This means that no matter when an employee might leave an employer, 100% of the employee’s contributions will always be theirs, no matter if they keep it in the plan, roll it over to another employer’s plan or into an individual retirement account (IRA).

Vesting thus refers specifically to the employer’s contributions into the plan for the employee. This is generally in the form of matching dollars on employee contributions or profit sharing.

These dollars are subject to a vesting schedule. Simply put, generally the longer an employee stays, the more they keep if they leave with the time calculated from date of hire.

Common vesting schedules include:

• Cliff vesting, where there may be no vesting for the first year or two, then 100% vesting
• Tiered vesting, where a certain percentage is vested each year.

An example schedule of tiered vesting over six years might be zero the first year, then 20%, 40%, 60%, 80%, and finally 100% vesting starting the first day of the sixth year of employment.

Thus an employee who leaves in their fourth year of employment would be just 60% vested.

Safe harbor

So what happens to the remainder?  This is forfeited back to the plan and is generally distributed among the remaining participants as an offset to the plan match or used by the employer to reduce the expenses of the plan for the benefit of the remaining participants.

Note that, in certain circumstances, employer contributions may be 100% vested immediately. A “safe harbor” plan is the best example.

The second application is vesting of stock options given to an employee by an employer. In this sense, the benefit is generally viewed as vested when the options “come due” and are able to be controlled by the employee for exercise, sale or retention.

Not unlike with a certificate of deposit, a specific date typically is indicated. There may also be a vesting schedule similar to tiered vesting described above.

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