Vesting: What It Is and How It Works

Vesting is the process by which an employee earns non‑forfeitable ownership of certain employer‑provided benefits, such as retirement plan contributions, stock options, or restricted stock units (RSUs). Employers use vesting schedules to encourage retention by tying full ownership of those benefits to continued employment over time.

Key points

• Employee contributions to employer‑sponsored retirement plans (for example, your own 401(k) deferrals) are immediately 100% vested.
• Employer contributions (such as matching 401(k) dollars or stock grants) often vest over time according to a schedule.
• Common vesting periods range from three to five years, though employers set the specific terms.
• Vesting grants ownership rights but does not eliminate plan rules about withdrawals or taxes (e.g., penalty rules and required distribution ages).

How vesting works

1. You receive a benefit (employer match, RSU grant, pension credit).
2. The employer sets a vesting schedule that determines when those contributions or shares become non‑forfeitable.
3. If you leave before becoming vested in the employer portion, the unvested portion is typically forfeited.

Example (RSUs): An employee receives 100 RSUs with a five‑year vesting schedule:
* Year 2: 25 units vest
* Year 3: 25 units vest
* Year 4: 25 units vest
* Year 5: 25 units vest
If the employee leaves after year 3, they keep the 50 vested units and forfeit the remaining 50.

Types of vesting schedules

• Cliff vesting
• The employee becomes 100% vested all at once after a specified period (e.g., fully vested after three years).
• Graded (or graduated) vesting
• Ownership vests gradually over a set period (e.g., 20% per year over five years).

Example of graded vesting over six years: 0% after year 1, then 20%, 40%, 60%, 80%, and 100% after years 2–6.

Where vesting is used

• Employer retirement plans (401(k) matches, pension credits)
• Equity compensation (stock options, RSUs)
• Some estate and bequest arrangements (delayed or contingent inheritances)

Why employers use vesting

Vesting aligns employee incentives with company goals and improves retention by making certain benefits contingent on continued service. Startups frequently use multi‑year vesting for equity grants to motivate long‑term commitment.

Practical considerations

• Vesting gives you ownership but withdrawal and tax rules still apply according to the plan and relevant laws (for retirement plans, penalty‑free withdrawals typically require reaching age 59½ or meeting other plan conditions).
• When changing jobs, check the vesting status of employer contributions and equity grants so you know what you’ll keep or forfeit.

Bottom line

Vesting determines when employer‑provided benefits become permanently yours. Understand your employer’s vesting schedule so you can plan career moves and retirement decisions with a clear picture of which assets you will retain.