What it means
Employers use vesting to reward loyalty. A company might promise a pension or matching contributions, but require the employee to stay for a certain number of years before the promise becomes permanent.
The rules vary by country and by type of plan, and the law usually sets a maximum waiting period. Vesting can happen all at once or in stages.
Under "cliff" vesting, nothing is yours until a set date, such as after three years, and then everything vests together. Under "graded" vesting, a slice vests each year, so an employee might be 20% vested after one year, 40% after two, and so on.
It is important to separate what has been earned from what has vested. An employee may have accrued a pension worth $20,000 a year based on their service so far, but only the vested part is guaranteed if they leave tomorrow.
The unvested part might still be earned if they stay long enough. For the employer, vested benefits are firm obligations that appear in the financial statements through the pension liability.
The company's accountants and actuaries (specialists in measuring long-term financial risk) estimate their present value, and shortfalls between that value and the plan's assets can affect the company's reported position. For employees, the practical advice is simple: check the vesting schedule before deciding to change jobs.
Leaving a few months before a vesting date can mean giving up a significant amount, while staying a little longer might secure it. For a prospective employee, the vesting schedule is part of the total pay package and should be valued like salary.
Two offers with the same base pay can differ widely in value if one vests quickly and the other makes you wait for years. Ask for the schedule in writing before you accept.
In practice
Real-world examples.
Example
A software engineer at a large employer is offered a job elsewhere in her third year. HR confirms that her pension vests fully after five years, so she negotiates a start date and a sign-on payment to make up for what she would lose. Her negotiation shows that vesting terms can be traded against other parts of the offer.
Example
A manufacturing company uses cliff vesting for its matching retirement contributions. An employee who leaves after two years and eleven months gets none of the match, while one who stays a month longer keeps all of it. A single month of service decides whether the whole match is kept or lost.
Example
A finance director reviewing the company's pension note sees that a large share of the liability relates to employees who have already vested. She concludes that staff turnover will not reduce that part of the obligation. Her reading also shows why the assumptions about staff turnover in the pension note deserve attention.
Formula
Calculation
Vested benefit = accrued benefit x vested percentage
An employee has accrued a pension entitlement of $20,000 a year based on service to date. Under the plan's graded schedule, she is 60% vested. Vested benefit = 20,000 x 0.60 = $12,000 a year. The remaining $8,000 is unvested. If she stays another year and reaches 80% vesting on a larger accrued benefit of $24,000, her vested benefit becomes 24,000 x 0.80 = $19,200 a year.Case study
Seen in the real world.
Alder Foods is an illustrative, fictional company with 800 employees and a defined benefit pension plan, where the employer promises a set income in retirement. Management considered lengthening the vesting period from three years to five to reduce costs.
The finance team calculated that most of the savings would come from newer, younger staff leaving before vesting. But they also found that longer vesting could make recruiting harder and might encourage experienced workers to leave just before the new rules applied.
In this illustrative case, the board kept the three-year period. The accounting benefit of a lower liability did not outweigh the damage to retention and morale, and any change to a plan would also have needed to respect the legal minimums.
Watch out
Common mistakes.
- Confusing accrued benefits with vested benefits, when only the vested part is guaranteed if the employee leaves.
- Assuming the rules are the same for every plan, when the schedule can differ between pensions, matching contributions and share awards.
- Resigning shortly before a vesting date without checking the schedule, and giving up an entitlement that was almost earned.
Questions
People also ask.
Are an employee's own contributions always vested?
Usually yes, since money the employee puts in is generally theirs immediately, while the employer's contributions follow the vesting schedule.
Can a vested benefit be taken away?
Generally no, because it is a legal right, although the plan may be amended for future service or benefits not yet earned.
What happens to unvested benefits when an employee leaves?
They are usually forfeited, which reduces the employer's cost or is returned to the plan.
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