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What Is Vesting?
Vesting is a process by which an employee obtains ownership rights in work-related benefits, such as stock options, stock shares, and certain retirement plan assets.
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How Vesting Works
Employees commonly contribute a percentage of their paycheck to their 401(k)s, and their employer may match part or all of that contribution. Employee contributions immediately vest and are completely owned by the employee. 1 Employer contributions to a 401(k) plan might or might not vest immediately. A company may have a vesting schedule that determines when employees acquire full ownership of the portion contributed by the employer. In fact, matched dollars usually take several years to vest, meaning an employee must stay with the company long enough to be eligible to receive them.
The vesting process for stock bonuses offers employers a valuable employee retention tool. For example, an employee might receive 100 restricted stock units as an annual bonus.
To entice this valued employee to remain with the company for five years, the stock may vest according to the following schedule:
25 units in the second year after the bonus was awarded
25 units in year three
25 units in year four
25 units in year five
If the employee left the company after year three, only 50 units would be vested. The other 50 would be forfeited. This means the employee would have ownership rights for 50 units and lose the opportunity to own 50 more.
Types of Vesting
- Cliff Vesting Schedule: Gives the employee ownership of 100% of the employer’s contributions all at once after a certain number of years.
- Graded Vesting Schedule: Gives the employee ownership of a percentage of the employer’s contribution each year.