An employee is considered "vested" in an employer benefit plan, once they have earned the right to receive benefits from that plan. Cliff vesting is when the employee becomes fully vested at specified time rather than becoming partially vested in increasing amounts over an extended period of time. An example of "cliff vesting" would be when an employee is fully vested in a pension plan after 5 years of full time service. Partial vesting would occur if the employee were considered 20% vested after two years of employment, 30% vested after three years of employment and 100% vested after 10 years of employment. In a cliff vesting pension plan, if an employee leaves the company before becoming fully vested, he or she would not receive any retirement benefits.

For more on this topic, be sure to read our Retirement Plans Tutorial.

The Advisor Insight

Cliff vesting relates to employer-sponsored retirement plans, employee stock option plans and restricted stock units.

The term describes the schedule in which an employee's benefits are paid (or "vest") all at once on a given date. Alternatively, vesting can happen over time on a defined schedule. This is known as gradual vesting. As an example, an employee’s stock options could vest either at a rate of 20% a year for five years ("gradual vesting") or all at once after five years ("cliff vesting").

Chris Chen
Insight Financial Strategists LLC
Waltham, MA