If you have a retirement savings account, you’ve likely heard the term vesting. If you’re unsure of what it means or how it works, Slavic401k has all the answers you need. Read on to learn what vesting is, how vesting schedules work, and why vesting exists.
The term vesting means that someone has earned a right, and when it comes to retirement funds, it means that the investor has earned the right to the contributed funds or stock options after a specific period of time has passed.
Employers use vesting to keep employees incentivized to stay with the company for a longer period of time, rewarding their years of service once a specific timeline is met.
What is a Vesting Schedule?
A vesting schedule is used for employer-sponsored retirement accounts to ensure that company funds are not fully given to an employee until a specific amount of service is completed, typically between two and five years.
Essentially, an employer will match an employee’s retirement contributions on a payroll schedule. For example, if an employee contributes 3% of their salary, an employer may contribute an additional 3% match, leaving the employee with 6% of their salary in retirement accounts each year. If employment is terminated for any reason before the retirement funds vest, then the employer will gain their contributions back, leaving the employee with only the funds they contributed on their own – in this case, 3%.
It’s important to note that funds contributed by the employee are always 100% vested and cannot be harmed in the termination of employment.
Types of Investing Schedules for Retirement Accounts
If you’re unsure which type of vesting schedule your company has, review these common schedules:
- Cliff Vesting: This type of plan vests 100% of the employer’s funds after a specific period of time passes. Until then, the employee has 0% vested funds from the employer.
- Graded Vesting: This type of schedule allows employees to earn a percentage of their funds as time goes on. For example, after one year of employment, the employee may have 10% of their account vested, and after two years, they will have 50%, and so on. If an employee leaves the company before 100% of the employer’s contributions have vested, they only miss out on the percentage they have not earned through the graded schedule. If an employee left their employer after two years of service, they would retain 50% of their employer match dollars.
- Immediate Vesting: While uncommon, some companies offer immediate vesting, meaning that an employee will get 100% ownership of the employer match dollars as soon as it’s applied to their account.
Vesting Schedules for Stock Options
Some companies offer stock options as a form of retirement. This type of plan typically allows an employee to buy company stock at a set price, regardless of market value. The idea is that the stock market price will rise above the employee’s set prices before the stock option is used, allowing participating employees to make a profit.
If you work for a company with stock options, you may have a graded or cliff vesting schedule to adhere to as well, though there are slight differences in the terms compared to a 401(k)-vesting schedule.
- Cliff Vesting for Stocks: Employees have access to all stock options at the same time but cannot use any of their options to buy shares until they reach a specific employment period, such as three or five years.
- Graded Vesting for Stocks: This plan allows employees to exercise a portion of their stock options. With a graded schedule, employees can purchase a smaller percentage of shares each year until they are eligible for 100% at a specific employment date, like five years.
Vesting is a way that companies protect their assets, and as an employee, it’s important to note which policy your employer has. The vesting schedule can determine how long you work there, how much you contribute to your retirement fund, and more. If you’re unsure, reach out to your company’s human resource or benefits team for the appropriate information related to your plan
For additional 401(k) information, view our glossary guide. To learn about finances, retirement, savings, and spending, visit the Slavic401k blog.