Vesting schedule: Overview, definition, and example
What is a vesting schedule?
A vesting schedule is a timeline or set of conditions that outlines when an employee gains full ownership of certain benefits, such as retirement plan contributions, stock options, or other equity awards, provided by their employer. Typically, vesting schedules apply to employer-provided benefits like a 401(k) match, stock options, or other deferred compensation. Employees are required to stay with the company for a certain period before they can access or "own" these benefits outright.
Vesting schedules can be either time-based, meaning the employee must work for the company for a certain number of years before the benefit is fully vested, or performance-based, meaning the employee must meet certain performance targets or milestones. The most common vesting schedules are graded vesting (where benefits vest in increments over time) and cliff vesting (where the employee becomes fully vested at a specific point in time).
Why is a vesting schedule important?
A vesting schedule is important because it provides an incentive for employees to stay with the company longer, which benefits both the employee and the employer. From the employer's perspective, a vesting schedule helps to retain talent and reduce turnover, while also ensuring that the company’s financial commitments are aligned with the employee's tenure and contribution.
For employees, understanding the vesting schedule is essential, as it dictates when they will have full access to certain benefits. Vesting schedules provide a structured timeline for employees to plan their financial futures, especially when the benefits are significant, such as stock options or retirement contributions.
Understanding a vesting schedule through an example
Imagine a company offers stock options to its employees, but the stock options are subject to a four-year vesting schedule. The vesting is done on a graded basis, meaning 25% of the options vest after each year of service. This means that after one year, the employee can exercise 25% of their options, after two years, 50%, and so on, until they are fully vested in all options after four years.
In another example, a company offers a cliff vesting schedule for its 401(k) match, where the employee must work for the company for three years before the company’s contributions to the employee's retirement plan fully vest. If the employee leaves the company before the three-year mark, they forfeit the company's contributions to their retirement plan.
An example of a vesting schedule clause
Here’s how a vesting schedule clause might look in a stock option agreement:
“The Employee shall receive stock options under the Company’s Stock Option Plan. These options will vest over a period of four years, with 25% of the options vesting on the first anniversary of the grant date and the remaining 75% vesting in equal monthly installments over the next three years, subject to the Employee’s continued employment with the Company. If the Employee’s employment is terminated prior to the vesting dates, any unvested options will be forfeited.”
Conclusion
A vesting schedule is a key element in employee benefit plans, particularly for stock options, retirement benefits, and other forms of deferred compensation. It provides a clear structure for employees to understand when they will fully own the benefits provided to them by the employer. For employers, vesting schedules serve as an effective tool to retain employees and align their long-term interests with the company's success. By clearly defining the vesting schedule, both parties can set expectations and avoid misunderstandings about when benefits can be accessed.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.