What is 'Graded Vesting'

Graded vesting is the process by which employees gain, over time, ownership of employer contributions made to the employee's retirement plan account, traditional pension benefits or stock options. Graded vesting differs from cliff vesting, in which employees become immediately 100 percent vested following an initial period of service; and immediate vesting, in which contributions are owned by the employee as soon as they start the job.

BREAKING DOWN 'Graded Vesting'

Graded vesting encourages employee loyalty since the vesting plays out over a few years of continuous employment. Many employers offer matching contributions to workers’ tax-deferred retirement accounts, as a way to attract employees and to score corporate tax benefits. In some cases these matches are 100 percent, up to certain limitations, perhaps 7 percent of salary. In that case an employee who earns $75,000 and contributes 7 percent of his earnings to a 401(k) account would save $10,500 towards retirement every year, with only $5,250 coming out of their own pocket. 

Over many years, that employer contribution dramatically boosts retirement savings. But while those contributions are real money that gets invested every year, the principal and potential gains show up only on paper until the employee is vested.

A Typical Graded Vesting Schedule Is Six Years

In a typical graded vesting schedule, an employee becomes vested in 20 percent of their accrued benefits following an initial period of service, with an additional 20 percent in each following year until full vesting occurs. The initial period of service often varies. 

For example, if an employer's contribution is based on a fixed percentage of the employee's contribution, the initial period of service might be two years. After two years, the employee would be 20 percent vested, after three years, 40 percent, with the employee eventually becoming fully vested after six years.

Federal Laws Apply

Employers must follow certain federal laws that determine the longest allowable vesting periods, generally six years; however, they are free to choose shorter periods. In addition, if a plan is terminated, all participants become fully vested immediately. Contributions to SEPs and Simple IRAs always fully vest immediately. And an employee’s personal contributions to any retirement plan are always fully vested and belong to the employee even should they leave the job.

It’s important for employees to understand their company vesting schedule, since quitting a job before the full vesting period could mean leaving free money on the table, whether in the form of tax-deferred retirement savings, a pension plan or stock options.

RELATED TERMS
  1. Vesting

    Vesting is a legal term that means to give or earn a right to ...
  2. Vested Benefit

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

    Being fully vested means a person has rights to the full amount ...
  4. Cliff Vesting

    In cliff vesting, employees receive full benefits from their ...
  5. Accelerated Vesting

    Accelerated vesting allows an employee to quicken the schedule ...
  6. Employee Stock Option - ESO

    An employee stock option offers specified employees the right ...
Related Articles
  1. Retirement

    Calculate Penalties on a 401(k) Early Withdrawal

    How to calculate the penalties on early withdrawals from your 401(k), including the 10% tax penalty, vesting and income tax.
  2. Investing

    How Restricted Stock Units Work

    Restricted stock units (RSUs) are beneficial to both the employer and the employee and are easier to navigate than stock options.
  3. Personal Finance

    What to Do With Company Restricted Stock

    Having a financial plan that includes restricted stock will help you to avoid paying higher taxes.
  4. Retirement

    5 Companies With the Best Retirement Plans

    Ever wonder how your company retirement plan stacks up against the country's best employers? Take a peek at these great retirement plans.
  5. Retirement

    Benefits Of A SIMPLE IRA

    If you're at a small company, you may be offered a SIMPLE IRA retirement plan. Contribution limits are lower, but vesting is instant, with other benefits.
  6. 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.
  7. Investing

    Your 401(k) Plan: Just How Outdated Is It?

    A recent GAO report indicates that many 401(k) plans are still clinging to archaic rules that hinder plan participants’ ability to save.
  8. Retirement

    How 401(k) Matching Works

    Find out how employer matching of your 401(k) contributions works, including how employer contributions are calculated and annual contribution limits.
RELATED FAQS
  1. 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 >>
Trading Center