Many businesses use benefits as a way to attract employees. For many employer-sponsored benefits, you can decide to contribute funds. To improve employee retention at your business, and increase your company’s bottom line, you might institute a vesting schedule for your contributions. What is vesting?
Definition of vesting
Vesting is synonymous with ownership. If something is vesting, it means an individual will have ownership of it in the future. If something is fully vested, an individual has complete ownership of it presently. Payments, small business employee benefits, or other assets can go through vesting.
Common benefits that undergo a vesting period include 401(k) retirement plans and stock options. Vesting gives employees ownership of these employer-provided benefits after a period of time.
Vesting can be a strategy to retain employees. Many employers give benefits to employees only after they have vested for a certain number of years. This encourages employees to stay or forfeit the vesting funds.
Items that are vesting follow a vesting schedule. The vesting schedule determines when the employee has ownership over the assets.
A vesting schedule also postpones your payout to employees, which can provide more short-term cash for your company. Your business doesn’t need to dole out cash to employees until the funds have vested.
Your contributions to an employee’s benefits plan become nonforfeitable according to the vesting schedule.
If an employee leaves before something is fully vested, they forfeit however much is not vested. An employee has the rights to partially vested benefits.
Employees should make sure they understand the vesting agreement to avoid problems down the road. Sit down with any employees who have questions about their vested options.
Employee contributions are never subject to vesting. When an employee contributes money to their 401(k) plan, the money is theirs.
Employer contributions, on the other hand, can be subject to vesting if you choose.
Let’s say you contribute $1,000 each year to an employee’s 401(k) plan. According to your vesting schedule, the employee only has the right to those funds after three years. The employee leaves after one year. Although they still have the right to the funds they contributed to their plan, they must forfeit your contributions.
An employee who has a partially or fully vested 401(k) cannot withdraw the funds until they reach retirement age. A fully vested 401(k) simply means the employee has complete ownership over their and their employer’s contributions.
Many businesses also establish employee stock options plans to attract and retain employees. Employees can purchase a certain amount of shares in their company for a set price. But, the employee does not have ownership of their stock until the vesting period is complete.
Creating a vesting schedule
As the employer, you must create a vesting schedule to meet your business needs. You can either use a cliff vesting or graded vesting schedule.
Cliff vesting is a sudden change. A cliff vesting schedule means an employee does not have ownership of any funds until they have worked at the business a certain amount of time. Then, the employee has the right to 100% of the benefits. But if the employee leaves before their benefits are vested, they lose 100% of them.
Graded vesting is more gradual. A graded vesting schedule increases an employee’s ownership in something steadily over the course of a few years.
Take a look at the IRS’s vesting schedule to get an idea:
Graded vesting example
Let’s say an employee has $10,000 worth of funds that are vesting. You use a graded vesting schedule that is the same as the one the IRS provides (above).
Below, find out how much the employee is entitled to based on when they leave your company.
- If the employee left after the first year, they would have the right to $0, or 0%.
- If the employee left after the second year, they would have the right to $2,000, or 20%.
- If the employee left after the third year, they would have the right to $4,000, or 40%.
- If the employee left after the fourth year, they would have the right to $6,000, or 60%.
- If the employee left after the fifth year, they would have the right to $8,000, or 80%.
- If the employee left after the sixth year, they would have the right to $10,000, or 100%.
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This article is updated from its original publication date 4/11/2018.This is not intended as legal advice; for more information, please click here.