Vested Benefit: What It Is and How It Works
A vested benefit is a right to receive a full employer-provided benefit once an employee meets specified service or performance conditions. Employers use vesting to encourage retention by granting benefits gradually or all at once after a set period.
Vesting Methods
- Graduated (graded) vesting: ownership of the benefit increases in steps over time (e.g., 20% per year).
- Cliff vesting: employees receive no benefit until a single specified date, at which point they become fully vested.
Common Types of Vested Benefits
- Retirement plan balances and employer matching contributions (401(k), pensions)
- Employee stock options or company stock awards
- Cash bonuses or deferred compensation
- Health benefits and other employer-provided plans (where applicable)
Examples
An employee awarded 100 company shares might vest 20% after year two, 40% after year three, and so on until reaching 100% after year six. Between years two and five the shares would be partially vested; after year six they are fully vested.
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How Vesting Is Applied
- Employee contributions to a 401(k) are typically always vested (the employee’s own money is theirs).
- Employer matching contributions often vest over time according to the employer’s schedule.
- Stock awards and deferred-compensation plans commonly follow graded or cliff schedules set in plan documents or employment agreements.
- Vesting terms can be negotiated in union contracts or individual employment offers.
Legal and Accounting Considerations
U.S. federal rules under the Employee Retirement Income Security Act (ERISA) set minimum standards for participation, vesting, benefit accrual, and funding of retirement plans. As employees accumulate vested benefits, employers may have increasing funding obligations that must be reported in financial statements.
Key Takeaways
- A vested benefit is the right to a full employer-provided benefit after meeting the plan’s conditions.
- Vesting can be graded or cliff-style and applies to retirement plans, stock awards, cash compensation, and other benefits.
- ERISA provides protections and minimum rules for many retirement-related vesting arrangements.
- Employer matching and other employer-provided portions of benefits may vest on a schedule and can create accounting liabilities for the employer.