WTFinance: What is Vesting?

Vesting, or to vest, is a term that usually refers to when an employee has access to certain employer benefits. Two of the most common scenarios where vesting comes into play are with employee stock options and access to matching contributions to something like a 401(k) account. Vesting is also occasionally used in inheritance situations or certain real estate transactions.

What is Vesting?

It’s important to understand the concept of vesting, especially if you are in a situation where you have access to a 401(k) account employer match or stock options / grants from your employer. In most cases, while the matching money or stock options might show up in your account, you do not have full access to them right away. Instead, they will vest according to the agreement between you and your employer. 

Your matching dollars or stock grants may completely vest after a certain period of time, or they may vest according to a vesting schedule. Before they vest, you would typically lose access to your options or matching dollars if you left the company. Once you have completed whatever vesting schedule is set by your employer, you are considered “fully vested”. That means that the money or options are now yours, even if you leave the company.

How Does Vesting Work?

There are two common ways for vesting to work:

• Length of service — your employer may grant options or matching dollars as part of your initial employment offer, but vest them only once you have reached a certain employment milestone. This is typically one to three years — if you leave the company before then, you will lose your options or grants.
• Over time — in some cases, an employer may vest these items over time. In this scenario, you may vest a certain percentage of your options every paycheck or every year.

Less common (but still a possibility) is that your employer matching dollars or options might vest according to something besides length of service in your job. This might include hitting individual performance targets or job performance goals or the company itself meeting certain financial or other metrics. If you’re not sure about if or how your options or employer matching dollars vest, contact your HR or Finance department. It’s important to understand when you have complete access to this money.

What is a Vesting Schedule?

As the name implies, a vesting schedule comes into play when a company decides to vest options or matching 401(k) dollars over time. Here’s an example to illustrate how a vesting schedule works:

• Upon being hired, your employer gives you a grant of 20,000 stock options
• According to your employment contract, these options vest over a 4 year period, with ¼ of the options vesting each year
• Each year on the anniversary of your starting with the company, 5,000 of your options will vest.
• If you leave the company before your first anniversary, you will lose all of your options
• If you leave the company after 3.5 years, you will get 15,000 (¾) of your options.
• If you leave the company at any point after working there for four years, you will receive all of your options.

It’s also possible that a vesting schedule can be set up to vest a smaller percentage every pay period, similar to the way many employers set up PTO accrual. In our scenario, with 20,000 stock options vesting over four years, you’ll get 1/104 of your options each bi-weekly pay period. So every two weeks, approximately 192 of your options would vest. This is considered more employee-friendly, since there isn’t a hard cutoff like your yearly anniversary.

When (and Why) Do Companies Use Vesting?

As we’ve mentioned, the two most common reasons when companies use vesting are when:

• They offer an employer match to a 401(k) or 403(b) account
• They issue stock options or grants

Companies often issue this money according to a vesting schedule or agreement because they want to make sure that you have some incentive to stay with the company. If there was no vesting, employees might receive a grant worth tens of thousands of dollars (or more) and then immediately leave the company. With vesting, employers try to ensure that their employees have some skin in the game.

The Bottom Line

Vesting is a term that is important to understand if you’re in a situation where your employer has given you stock grants or options, or contributed an employer match to a 401(k) or 403(b) account. With vesting, you may not get immediate access to these financial grants or dollars. Instead, you may only receive them once certain conditions are met, often related to the amount of time that you work or according to a vesting schedule where you get access to a percentage over time. In either case, if you leave before the vesting has completed, you may lose thousands of dollars or more. So you’ll want to make sure you understand how and when your options, grants or matching dollars vest so that you can make the best financial decision for your unique situation.