What is 'Vesting'
Vesting is the process by which an employee accrues non-forfeitable rights over employer-provided stock incentives or employer contributions made to the employee's qualified retirement plan account or pension plan. Vesting gives an employee rights to employer-provided assets over time, which gives the employee an incentive to perform well and remain with the company. The vesting schedule set up by the company determines when the employee acquires full ownership of the asset. Generally, non-forfeitable rights accrue based on how long the employee has worked there.
BREAKING DOWN 'Vesting'
The exact requirements for vesting are specified in the plan document, which also contains any applicable regulations. 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: 25 units in the second year after the bonus, 25 units in year three, 25 units in year four and 25 units in year five. If the employee leaves the company after year three, only 50 units would be vested while the other 50 are 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. Or, 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 using a graded vesting schedule, which 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 doesn’t 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.