What Is Graduated Vesting?
Graduated vesting is the acceleration of benefits that employees receive as they increase the length of their service to an employer.
Federal law mandates that employers establish a vesting schedule for most employer contributions to company retirement plans. The schedule specifies the minimum number of years a company may require employees to work before they earn the right to all or part of the employer contributions made to their accounts.
How Graduated Vesting Works
A graduated vesting schedule for a defined benefit (DB) plan requires an employee to have worked for a certain number of years in order to be 100% vested in the employer-funded benefits.
For example, an employee may have to work for seven years to become fully vested but will be 20% vested after three years, 40% vested after four years, 60% after five years, and 80% after six years of service. If they leave the company before putting in six years, they lose a portion of the money that the company invested for them.
A defined benefit plan is a type of pension plan. The retirement benefits for each employee are computed using a formula that considers factors such as length of employment and salary history.
Defined benefit plans have restrictions on whether and how an employee can withdraw funds without penalties. The employer and/or their asset manager are responsible for managing the plan's investments and they assume all investment risk.
Annual Additions and Vesting Periods
When starting work for a new employer, an employee must often wait a period of years to begin receiving employer contributions to a retirement plan. The employee may begin contributing sooner but the employer match is delayed to ensure that the employee stays long enough to begin adding value. The graduated vesting period may be determined in the job negotiation phase.
Graduated vesting is common in start-up environments, in which vesting with stock bonuses helps sweeten the pot during a period of difficult growth. For example, an employee’s stock might become 25% vested in the first year, 25% the second year, 25% the third year, and fully vested after four years. An employee who leaves after just two years forfeits half of the bonus.
In a SEP plan, employer contributions are made on a discretionary basis. The employer decides each year whether to make a contribution and how much to make. In a SIMPLE plan, the employer is allowed a tax deduction for contributions and may also elect when and whether to make matching contributions.