What Is a Vested Interest in Financial Parlance?

What Is a Vested Interest?

A vested interest generally refers to a personal stake or involvement in a project, investment, or outcome. In finance, a vested interest is the lawful right of an individual or entity to gain access to tangible or intangible property such as money, stocks, bonds, mutual funds, and other securities at some point in the future. There is usually a vesting period or time span before the claimant may gain access to the asset or property.

Understanding Vested Interest

The term vested interest can mean many different things depending on the context. A vested interest exists for individuals who have a claim or a right to ownership of a piece of property without any reliance on anything else, even if the person doesn't possess the asset right away. So an interest becomes vested if the asset's title or right can be transferred in the present or the future to another party. This means a person or other entity can have a vested interest in a tangible or intangible asset if there are no conditions to its ownership.

The time during which a person or entity is required to wait before exercising ownership of the asset is known as the vesting period. This period is normally prescribed by the company or person who holds the title to the asset. For instance, some companies may set up vesting periods of three to five years for employees in profit-sharing plans. In some instances, there is no vesting period, meaning the interest is transferred immediately.

Vested interests can exist in numerous entities throughout the financial landscape including pension plans and 401(k) plans, as well as stocks and options. Contributions within an employee pension plan often come with special conditions surrounding when the funds can be cashed out.

These plans are under the stipulation that the participant is entitled to make withdrawals from the balance at some point in the future. In this case, the participant or investor has a vested right to the earnings. The vesting period varies by pension plan before the participant gains access to funds.

There may also be restrictions on withdrawal amounts to a specific percent per vested year. For example, after waiting the five-year vesting period, Peter was allowed to withdraw 20% from his retirement fund each consecutive year.

Special Considerations

An employee who contributes money toward a 401(k) plan may also have a vested interest in the company match if the employer offers one. Companies that match their employee's 401(k) contributions typically have distinct vesting schedules set up.

These schedules dictate the amount of the company match an employee is entitled to based on their years of service. For example, a company may designate a 20% entitlement of matched funds for employees after one year of service. If Peter contributes to a 401(k) with a company match, he would be fully vested or entitled to the entire company match after five years of service. But if he leaves the company in three years, he would be allowed to take only 60% of the company match with him.

Some companies have vesting cycles that don't break the match down into portions. In other words, an employee is fully vested after working at the company for a set amount of time. Say Peter works for a firm in which eligible employees become fully vested in the company match after working for five years. If Peter leaves this firm after three years, he takes home none of the company match funds. Therefore, it's crucial for 401(k) participants to pay attention to their companies' vesting schedules. 

Vested Interest vs. Vested in Interest

Vested interest should not be confused with vested in interest. This term, unlike vested interest, applies to entities such as trusts. The beneficiary of a trust is vested in interest if they do not have to meet any condition for their interest to take effect. In this case, the recipient has a present right to future enjoyment, such as a right to property when another beneficiary's interest ends. In this case, that beneficiary has access to the property when the primary beneficiary becomes deceased.