DEFINITION of Graduated Vesting
Graduated vesting is the acceleration of benefits that employees receive as they increase the duration of their service to an employer. Federal law mandates a vesting schedule for many employers' contributions to private retirement plans. It 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.
BREAKING DOWN Graduated Vesting
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.
Defined benefit plans are employer-sponsored retirement plans where employee benefits are computed using a formula that considers factors, such as length of employment and salary history. Defined benefit plans place restrictions on when and by what method an employee can withdraw funds without penalties. In a DB plan, the employer and/or their associated asset manager(s) are responsible for managing the plan's investments and assumes all investment risk.
Annual Additions and Vesting Periods
When beginning with a new employer, an employee must often wait a period of years to begin receiving annual additions to her retirement plan. Although she can often begin contributing sooner, this benefit is often delayed to ensure that the employee stays in the position long enough to begin adding value. A graduated vesting period is usually determined in the job negotiation phase.
Graduated vesting is common in many start-up environments, where vesting with stock bonuses can to help sweeten the pot for a valued employee to stick with the company during a period of difficult growth. For example, an employee’s stock could become 25% vested in the first year, 25% the second year, 25% the third year, and fully vested after four years. If the employee leaves after just two years, she forfeits 50% of her vesting capabilities.
In some cases, vesting is immediate (instead of gradual), such as with employees’ own salary-deferral contributions to their retirement plans, as well as SEP and SIMPLE plans. In a SEP, IRA contributions are made on a discretionary basis (e.g., the employer decides each year whether to make contributions to the plan). In a SIMPLE plan (or a Savings Incentive Match Plan for Employees of Small Employers), the employer is allowed a tax deduction for contributions and may also elect when to make matching or non-elective contributions.