Vesting Schedule

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Last Updated:October 12, 2023

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What Is A Vesting Schedule?

A vesting schedule is an incentive program where employees gain ownership of benefits, like stock options or pension funds, over a specific period, typically tied to their tenure with the company. It is a way for employers to retain high-performing employees.

Being "fully vested" means employees have complete ownership rights to these benefits after fulfilling the specified conditions and duration outlined in the company's policy.

This is how employers give their employees a reason to stay with the company. 100% Vested Benefits means that you will receive all retirement benefits or notice upon retirement.

For example, if an employee gets 7,500 shares or private equity options, their award schedule spans four years, and 25% of his awards are awarded yearly.

For instance, if an employee is granted 7,500 shares or private equity options, their vesting schedule might span four years, with 25% of the shares vesting each year, starting from the grant date. The employee's agreement should detail the specific dates and conditions for vesting.

Once each share vests, you can sell the shares. After four years, you will have full access to all stock options and can do whatever you want.

Key Takeaways

Vesting schedules are incentive programs where employees gain ownership of benefits (e.g., stock options or pension funds) over a specific period linked to their tenure.
There are three main types of vesting schedules: Time-Based Vesting, Milestone-Based Vesting, and Linear Vesting. Each has a unique approach to distributing benefits to employees based on specific criteria.
Vesting schedules, such as those in 401(k) plans, benefit employers by incentivizing high performers to stay longer and discouraging early retirements among low performers
When selecting a vesting schedule, consider factors like plan length, commencement date, vesting frequency, and the possibility of offering ownership upfront to attract and retain employees.

Types of vesting schedules

Vesting schedules are critical components in equity compensation plans, outlining the terms under which employees gain ownership of their awarded stocks or options.

Understanding the various types of vesting schedules is vital for both employers and employees, as they can significantly impact the long-term commitment and motivation of individuals within an organization

Some of the types of vesting schedules include:

Time-Based Vesting: Ownership granted after a specified time period, regardless of performance
Milestone-Based Vesting: Ownership granted upon achieving predetermined goals or performance milestones
Linear Vesting: Ownership accrues steadily over time, with no cliff or performance requirements

By understanding these structures, businesses can make informed decisions, fostering a motivated workforce while ensuring financial prudence.

Time-Based Vesting

Time-based vesting is a common method where employees gain ownership of assets or benefits after a specific period, usually years.

It does not rely on performance or milestones, ensuring gradual ownership accrual, promoting retention, and aligning interests between employees and the organization over time.

It allows employees to vest their share of stock options over time based on a fixed schedule, and cliff (when the employee's first option is granted and vested) is a vesting method for obtaining the stock options.

Once the cliff is reached, the remaining options will be issued monthly or quarterly, depending on its schedule.

Usually, companies offer vesting contracts with a one-year cliff. This means the minimum period an employee must remain with the company before accruing vested interest is one year.

Milestone-Based Vesting

Milestone-Based Vesting refers to a vesting method in which stock options and welfare benefits are granted to employees according to the achievement of certain milestones in the company.

Employees in a company's sales and marketing department can receive stock options after reaching certain goals. Similarly, accountants employed by accounting firms may be granted stock options after completing a certain number of monthly audits.

Examples of milestones that may be part of a milestone-based vesting schedule are:

A developer receiving stock option shares to develop the first version of a technology product for a startup
Marketers receiving stock options to build marketing strategies and programs for startups
Operations Professionals receiving Stock Options to Build New Accounting and Payments Systems for Startups

In contrast to an arbitrary scale such as hours, a milestone-based vesting schedule is more beneficial to employers as stock vesting is done only for low-risk, value-adding activities.

Note

Linear Vesting

Linear vesting is a method where employees accrue ownership gradually and consistently over time, without cliffs or performance conditions. The ownership increases steadily, aligning with the tenure.

The plan entitles employees to a fixed percentage of the shares offered to them over a period of time.

For example, during a four-year gradual vesting period, an employee receives 25% of the total shares after one year, 50% after two years, 75% after three years, and 100% after four years.

If an employee under this plan terminates within the vesting period, that employee will receive only the percentage accrued to that point.

There is also the option of a reverse vesting plan. In this plan, an employee may receive all shares in advance, but the company has the right to buy back unvested shares if the employee leaves early.

How Vesting Schedules Work

A typical vesting schedule occurs when an employee receives money through a company's 401(k) agreement. In cases like these, it takes years for the dollars to match. This means that the employee must renew their employment with the company to be eligible for full ownership.

Vesting schedules benefit employers because they are a valuable employee retention strategy, with high performers staying longer and low performers retiring earlier.

For example, consider an employer offering 100 units of its limited stock as part of a general benefit. For an employee who chooses to stay longer with the company, such as five years, shares will be awarded according to the following schedule:

Example
Year	2	3	4	5
Units Invested	50	50	50	50

The remaining 100 units will expire, but the units will vest. Some benefit plans vest immediately. A good example is a pension plan, where an employee's contribution to deferral is always credited at 100%.

This pattern is also evident in her SEP and SIMPLE employer contributions. An employee has immediate access to her 401(k) plan offered by her employer.

Alternatively, contributions can be vested immediately using either a cliff vesting scheme or a multi-level vesting scheme. In the first scenario, the employee gets 100% ownership of the investment after a certain period of time.

In the second case, the employee is entitled to an annual share of the employer's contribution. Traditional pension plans typically use 3- to 7-year staggered defined benefit plans and 5-year defined benefit plans.

Note

Employees are fully committed to their employer's contribution plan and cannot withdraw their allocated money anytime. You must be of retirement age to make fee-free withdrawals under the plan rules.

How To Choose A Vesting Schedule

Consider the following helpful tips to choose the best schedule to benefit your business and your valued employees.

1. Determining the plan length

For retirement plans, the standard vesting schedule ends at retirement age and may include options for early retirement or partial ownership before retirement age. For stock option plans, the standard term is often three to five years, and most employers offer four-year stock option plans.

2. Determining a Commencement Date

Choosing a commencement date for a vesting plan is another important consideration. The vesting start date is the start date of the schedule. This may be the first day of employment, one year, or five years later. Your chosen start date depends largely on your organization's needs and capabilities.

3. Setting the Vesting Frequency

The vesting frequency determines how often an employee can take stock options in a pension fund. The most common vesting frequency for stock option plans is monthly, quarterly, or annual.

Note

The most common vesting frequencies for retirement plans are once at retirement age or twice for early retirement options. Frequency can be expressed as a percentage or inventory amount.

4. Consider Ownership Upfront

A good option for a vesting schedule is to provide funds or partial asset ownership on the commencement date.

This is an effective incentive to attract new employees and encourage existing employees to enroll in vested benefit programs. This option is most effective when used with stock options on these plans, but it can also be applied to retirement account vesting plans.

100% or Fully Vested schedule

A "100% vested" or fully vested schedule refers to a scenario where employees have complete ownership of their employer-provided benefits or retirement funds. Once an employee is 100% vested, they have unrestricted access to the entire benefit amount, regardless of their continued employment status.

This status can be achieved through various means, such as completing a certain number of years of service, reaching retirement age, or other conditions outlined in the company's benefits policy.

Being fully vested is crucial for employees as it ensures they retain their entitled benefits even if they leave the company.

Employers design vesting schedules strategically to encourage employee retention, aligning the interests of the employees with the long-term goals of the organization and fostering a sense of financial security among the workforce.

Vesting Schedules in Retirement Plans

It's essential for employees to understand the implications of being fully vested in their retirement plans. Let's see a few scenarios related to vesting schedules in retirement plans, focusing on when employees become fully vested:

1. Plan Termination

If a retirement plan is terminated, employees' benefits become 100% vested, and they can take their accumulated money with them.

2. SEP, SARSEP, and SIMPLE IRA

In these specific types of retirement plans, all contributions made by both employees and employers are fully vested, meaning employees have immediate ownership of all the funds in their accounts.

3. Reaching Retirement Age

If an employee reaches the specified retirement age before the date outlined in the vesting schedule, their benefits become 100% vested, giving them complete ownership of their retirement funds.

4. Under 401(k) Plans

Certain contributions in 401(k) plans, such as Elected Deferrals, Eligible Unselected Contributions, and Eligible Matching Contributions, are always 100% vested, ensuring immediate ownership by employees.

Companies should have vesting options for two main reasons:

Employees can look forward to the long term by offering additional stock options or pension funds to help them stay with the company longer.
To prevent promoting bad attitudes. When a company hires someone and gives each new hire instant access to stock options instead of creating a vesting plan, it risks giving money to people who do not stay too long.

Note

A one-year cliff prevents companies from issuing stock to bad hires, as it often takes months to understand whether a new hire is a good choice for the company.

The Future of Vesting Schedules

Outdated vesting schedules can negatively impact start-ups by affecting employee morale, retention rates, and the company's ability to attract top talent. Having clear communication about vesting plans and their implications is vital for maintaining a motivated workforce.

A new company takes advantage of a loophole to make it appear that they are offering a vesting period for stock options without actually offering anything.

They do this by hiring employees on a four-year vesting schedule but waiting longer than four years to go public with the company.

Employees should have clear rights and protections concerning their stock options, including provisions for scenarios like delayed IPOs. Explaining these protections ensures employees are informed about their financial interests and legal entitlements.

Understanding the terms and the details of your company's vesting plan can help you plan for your future financial plans and consider your employer's contribution if you leave the company. Also, it helps reduce or eliminate the possibility of loss.

Employment decisions should not be based solely on a company's vesting plan. This is the case, as calculating benefits based on various vesting plans will help determine the amount of money an employer may provide to charge. You can fully retire when the time is right to recover your other assets.

If you do not know about your vesting schedule, connect with Human Resources, or you may refer to your Benefits Manual for details of these schedules required for your pension plans and more benefit accounts.