By Brian Abbott
Updated Jun25, 2019
Vesting is a legal term that means to give or earn a right to a present or future payment, asset, or benefit. It is most commonly used in reference to retirement plan benefits when an employee accrues nonforfeitable rights over employer provided stock incentives or employer contributions made to the employee’s qualified retirement plan account or pension plan. It also is commonly used in inheritance law and real estate.
Pension vesting for defined benefit plans can occur in a variety of ways. Your benefits can vest immediately, or vesting can be spread out over up to seven years.
It’s important to understand how your pension vests because the vesting schedule determines when you are eligible to receive full pension benefits.
Also, your plan’s vesting schedule might be a factor if you’re thinking about changing jobs. Perhaps, you don’t want to leave until you’re fully vested. In addition, the vesting schedule matters if you had a pension with an employer for whom you no longer work and want to know to what pension benefits you’re entitled.
In the context of retirement plan benefits, vesting gives employees rights to employer provided assets over time which gives the employees an incentive to perform well and remain with a company. The vesting schedule set up by a company determines when employees acquire full ownership of the asset.
Generally, nonforfeitable rights accrue based on how long an employee has worked for a company.
One example of vesting is seen in how money is awarded to an employee via a 401(k) company match. Such matching dollars usually take years to vest, meaning an employee must stay with the company long enough to be eligible to receive them.
Vesting within stock bonuses offers employers a valuable employee retention tool. For example, an employee might receive 100 restricted stock units as part of an annual bonus.
To entice this valued employee to remain with the company for the next five years, the stock vests according to the following schedule:
If the employee leaves the company after year three, only 50 units would be vested, and the other 50 would be forfeited.
For some benefits, vesting is immediate. Employees are always 100% vested in their salary deferral contributions to their retirement plans as well as SEP and SIMPLE employer contributions.
Employer contributions to an employee’s 401(k) plan may vest immediately. They may vest after several years using either a cliff vesting schedule, which gives the employee ownership of 100% of the employer’s contributions after a certain number of years, or by using a graded vesting schedule.
A graded vesting schedule gives the employee ownership of a percentage of the employer’s contribution each year. Traditional pension plans might have a five-year cliff vesting schedule or a three-to seven-year graded vesting schedule.
Just because you are fully vested in your employer’s contributions to your plan does not mean you can withdraw that money whenever you want. You are still subject to the plan’s rules, which generally require you to reach retirement age before making penalty free withdrawals.
Employees are always 100% vested in their own contributions to an employer sponsored retirement plan.
Vesting is common in wills and bequests and often takes the form of a set waiting period to finalize bequests following the death of the testator.
This waiting period before vesting helps reduce conflicts that could arise over the exact time of death and the possibility of double taxation if multiple heirs die after a disaster.
Startup companies often offer grants of common stock or access to an employee stock option plan to employees, service providers, vendors, board members, or other parties as part of their compensation.
To encourage loyalty among employees and also keep them engaged and focused on the company’s success, such grants or options usually are subject to a vesting period during which they cannot be sold. A common vesting period is three to five years.