Having a vested retirement plan is a great employee benefit. But with so many variations, options, and schedules, business owners and employees can struggle to understand what it really means.
That’s why we’ve compiled everything you need to know about vesting below. That way, you can begin to plan for a successful financial future without confusion.
What is Vesting?
In legal terms, ‘vesting’ means to earn the right to a present or future asset, benefit, or payment, like when an employer matches their employees’ 401k contributions. The term is commonly used when referring to retirement plans or compensation packages offered by employers. When used in this sense, vesting means that employees gain the rights to employer-provided assets over time. This predetermined time period is known as the ‘vesting schedule.’
What is a Vesting Schedule?
Essentially, the ‘vesting schedule’ dictates when an employee will get full ownership of their employer’s contributions, or when they’ll gain access to the offer.
Most schedules tend to follow a three-to-five-year plan. However, the structure and terms of these plans vary depending on the employer and what they’ve picked (graded, cliff, or immediate).
Most companies also opt to begin their vesting period upon employment, but some require employees to wait for the end of either a ninety-day probationary period or one year before starting.
When an employee meets the terms of the schedule and stays in service for the entire vesting period, they gain access to the contributions, even if they leave the job before retirement. Suppose they do choose to exit before retirement and have met the terms. In that case, the employee can roll over into a new plan, make distributions, or keep it and continue contributing independently.
But, if an employee leaves before fulfilling the criteria, their rights to the matching incentives depend on the extent of vesting achieved.
Types of Schedules
There are typically three kinds of schedules: immediate, graded, and cliff.
With immediate vesting, there is no designated waiting period for an employee to access benefits; this means employees can enjoy access and full ownership of them right away.
A graded vesting schedule allows an employee to receive small amounts of ownership over time, resulting in 100 percent ownership. (For example, 10 percent in year one, 25 percent in year two, etc.) Suppose an employee leaves before completing the time period. In that case, they’ll only get to keep the vested percentage of the employer’s matching contribution.
It’s important to note that graded vesting schedules cannot exceed six years (as outlined by federal law).
Cliff vesting differs because employees receive a lump sum of the benefit on a specified date, resulting in an ‘all or nothing’ benefit. For example, if the vesting schedule is two years, the employee would not receive any portion of it until they reached two years of working with the company.
Federal law requires that this type of schedule not exceed three years for qualified retirement plans.
Vested 401(k)’s
When a company offers a four percent match on 401k contributions for a predetermined amount of time, it follows a vesting schedule. This schedule means that employees will only have access to the matched contributions if they stay with the company for that predetermined time period.
It’s important to note that any contributions an employee makes to their retirement plans (through work) are 100% vested. This means that even if they leave the company early, they’ll have immediate access to the funds.
Just note that, before making a withdrawal, standard rules apply. So, employees will typically have to be of retirement age before being able to make a penalty-free withdrawal.
Vesting with Stocks
Employers also incentivize employees with stock option plans. These stock options give them the right to buy company stock at a set price (regardless of the market value).
Stocks usually vest at 25 percent per year over four years. This means that, at the four-year mark (from the grant date), the employee can sell or keep them.
But keep in mind that, once vested, employees don’t own the shares. Instead, they have earned the right to exercise shares in the future. So, if the share price is higher than the exercise price, it can be bought at a lower price so the employee can earn a profit.
Regardless, stock options are usually given with the expectation that the market price will rise. In theory, this leaves the employee with a profit when the stock is ready to be used.
Why do Employers Like It?
Vesting schedules reward employees who are loyal to the company while essentially penalizing those who terminate contracts early. This tends to foster a higher retention rate amongst high-performing employees because leaving early puts them at risk of missing out on the money or benefits being offered. So, they tend to stay longer to gain access to them.
Employers also like offering vesting schedules because they can pick the type of schedule that best suits them in terms of duration and percentage of shares vested each year. Choosing a well-tailored plan will therefore give employers a competitive edge in the industry, especially when hiring.
Still Struggling?
Vesting is hard to understand, especially when you’re trying to navigate the tricky terms and conditions on your own. If you’re an owner who’s struggling to come up with your own terms, know that you’re not alone; there are options that can help you create a comprehensive 401k package that benefits you and your employees.
The best option for this is peppermint PEP (Pooled Employer Plan). Choosing a Pooled Plan Provider (PPP) with other professionals in a PEP eliminates all the worry around plan structures. Plus, these plans offer more resources (including real-life professional help) that can assist with creation, implementation, and maintenance.
Empower your business strategy while increasing enrollment, expanding distribution, improving retention, and accelerating your business – without the administrative headache.
Our solution offers the flexibility to support any member base of any size with any requirements. Get in touch with us by phone at 844-399-8890 or by email at info@peppermintira.com so we can tailor the right platform solution that you and your members deserve.
The peppermint blog assumes no responsibility or liability for any errors or omissions in the content of this site. The information contained in this site is provided on an “as is” basis with no guarantees of completeness, accuracy, usefulness, or timeliness. It does not represent or replace actual financial advice provided by a certified financial professional. Since everyone’s situation is different, we always recommend addressing specific questions to your plan provider or certified financial professional. As such, peppermint may not be held liable for your use or reliance on any information contained herein.
