A vesting period refers to the amount of time in which an employee is required to work for an employer before he or she is able to fully own his or her shares of the employer’s stock option plan. Should the employee quit or be terminated before the vesting period ends, the company can buy back the shares of the stock for the original price. An employee is not permitted to sell or transfer stock options during a vesting period.
Vesting is the process in which an employee who has a qualified retirement plan or stock option plan must work for a company that provides said plan. Once the vesting period begins, the benefits that the plan offers cannot be revoked; as long as the employee has met the vesting period yet no longer works for the employer after meeting the qualifications of the period, the benefits of his or her stock option plan cannot be revoked.
Further Details on Vesting
Since vesting provides employees rights to the assets (stock option plans or retirement plans) that an employer provides, it offers employees an incentive to do a good job and remain working with a company until the period of vesting has been met.
The employer establishes a vesting schedule, which determines when employees are able to acquire complete ownership of an asset. Typically, rights that cannot be forfeited accumulate, and they are based on the amount of time an employee has worked with the company. A common example of vesting is a 401(k) company match, in which an employer matches every dollar that a person puts into the retirement plan at a certain percentage. Generally, this matching of dollars takes several years to vest. In other words, an employee is required to work with the company long enough to receive the benefits.
Types of Vesting Periods
There are various types of vesting and vesting periods. Each type offers a certain vesting period during which time an employee must continue to work for the employer before he or she receives full ownership of the benefits. Some of the different types of vesting periods include:
- Graded vesting. Also referred to as graduated vesting, this type of vesting period allows an employee to gradually gain ownership to full benefits over a period of several years. An employee might receive full ownership of a certain percentage of their potential shares after a certain period of time; 20 percent of the shares after three years, for example. After four years, the employee might receive 40 percent of the benefits, and after five years, he or she might receive 60 percent, after six years, 80 percent of the benefits may be available, and after working with a company for seven years, an employee would receive 100 percent of the benefits. In other words, after seven years would be fully vested. Should an employee leave the company prior to being fully vested – in year five, for example – he or she would be entitled to 60 percent of the vested benefits.
- Cliff vesting. With this type of vesting period, an employee is only entitled to the benefits once he or she has become fully vested. Should the employee not complete the vesting period, he or she will lose access to all of the benefits that they employer has paid for. For instance, an employee might a worker might acquire a 25 percent vesting benefit every year; however, if he or she leaves the company before working for five years, everything would be lost.
- Accelerated vesting. This type of vesting period might occur if a company makes an acquisition; in other words, a company might decide to offer employees accelerated vesting for 12 months. For instance, For example, if an employer offered 12 month accelerated vesting post acquisition, an employee who worked with the company for 3 years would now be vested for 4 years. Employees acquire extra time on their vesting schedule.
- Fully vested. This type of vesting period means that an employee has earned the full amount offered by his or her benefit. Some plans require employees to become fully vested in order to receive any benefits. If the employee doesn’t become fully vested, all benefits will be lost.
Wrapping it Up
A vesting period can be a very effective employee retention tool, as it encourages employees to remain with an employer in order to receive benefits. Greater employee retention leads to less loss monetarily and can ultimately increase sales.