What is 'Cliff Vesting'

Cliff vesting is the process by which employees earn the right to receive full benefits from their company’s qualified retirement plan account at a specified date, rather than becoming vested gradually over a period of time. The vesting process applies to both qualified retirement plans and pension plans offered to employees. Companies use vesting to reward employees for the years worked at a business and for helping the firm reach its financial goals.

BREAKING DOWN 'Cliff Vesting'

Assume that Jane works for GE and participates in a qualified retirement plan, which allows her to contribute up to 5% of her annual pre-tax salary. GE matches Jane’s contributions up to a cap of 5% of her salary. In year one of her employment, Jane contributes $5,000 and GE matches by putting in another $5,000. If Jane leaves the company after year one, she has ownership over the dollars she contributed, regardless of the vesting schedule.

Examples of Vesting Schedules

GE, Jane’s employer, is required to communicate the vesting schedule to employees and report the qualified retirement plan balance to each worker. If GE set up a four-year vesting schedule, Jane would be vested in 25% of the company’s $5,000 contributions at the end of year one. On the other hand, a three-year schedule using cliff vesting means that Jane is not eligible for any employer contributions until the end of year three.

How Employees View Vesting

A gradual vesting schedule rewards employees for staying at a company over a period of years, and the financial gain to the worker can be substantial. Cliff vesting, however, creates uncertainty for the employee, because the worker does not receive any benefit if he is fired before the cliff vesting date. This situation is common for startup businesses, since many of these companies fail in the first few years.

The Differences Between Defined Benefit and Defined Contribution Plans

When an employee becomes vested, the benefits the worker receives are different depending on the type of retirement plan offered by the company. A defined benefit plan, for example, means that the employer is obligated to pay a specific dollar amount to the former employee each year, based on the last year’s salary, years of service and other factors. For example, an employee may be vested in a benefit that pays $5,000 per month for the individual’s remaining life. On the other hand, a defined contribution plan means that the employer must contribute a specific dollar amount into the plan, but this type of benefit does not specify a payout amount to the retiree. The retiree’s payout depends on the investment performance of the assets in the plan. This type of plan, for example, may require the company to contribute 3% of the worker’s salary into a retirement plan, but the benefit paid to the retiree is not known.

  1. Graduated Vesting

    The accelerated benefits employees receive as they increase the ...
  2. Vested Benefit

    A financial incentive granted to employees who have met the required ...
  3. Fully Vested

    Fully vested is a person's right to the full amount of some type ...
  4. Vested Interest

    Vested interest refers to an individual's future right to tangible ...
  5. Unconditional Vesting

    Pension benefits that are entitled to the employee without any ...
  6. Withdrawal Benefits

    The rights of an employee who has a qualified pension plan to ...
Related Articles
  1. Personal Finance

    How Vesting Works and Why It's Important

    Vesting is an important part of your company's retirement or pension plan. Understand how and when you are fully vested at work.
  2. Retirement

    Pension Vesting: Everything You Need to Know

    Understanding pension vesting is tricky, but it’s crucial to making wise decisions about changing jobs and collecting the most pension benefits you can.
  3. Retirement

    Five Questions to Ask About Your Company's 401(k) Plan

    Having a comfortable retirement depends on taking maximum advantage of your company's 401(k), if it's offered.
  4. Small Business

    Plans The Small-Business Owner Can Establish

    Don't hesitate to adopt a smart plan for you and your employees.
  5. Taxes

    Is HD Vest Financial Services Right for You?

    Here's what you need to know about HD Vest Financial Services.
  6. Taxes

    How restricted stock and restricted stock units (RSUs) are taxed

    Find out how these forms of executive compensation work and how to deal with the tax consequences of them.
  7. Financial Advisor

    Understanding Rules on Defined Benefit Pension Plans

    Defined benefit plans offer advantages to both employers and employees. Employers must understand the federal tax rules when establishing these plans.
  8. Personal Finance

    Don't Lose out on Equity Compensation When You Retire

    Equity compensation can be a lucrative benefit that shouldn't be overlooked at retirement.
  1. Can my company ever be entitled to take my 401(k)?

    Find out why your employer may be able to take part of your 401(k) if you leave your employment too soon, including how different ... Read Answer >>
  2. How do I "vest" something?

    Vesting is a term usually related to pension plans that some employer's provide to their employees.An employer may make contributions ... Read Answer >>
Hot Definitions
  1. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  2. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  5. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  6. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
Trading Center