Graded Vesting: What It Is and How It Works

Definition

Graded vesting is a schedule that gradually grants employees ownership of employer contributions to retirement plans, pension benefits, or stock options over a series of years. Unlike cliff vesting (full ownership after a single waiting period) or immediate vesting (ownership from day one), graded vesting increases the employee’s vested percentage incrementally.

How graded vesting works

• Employers contribute to tax-deferred retirement accounts (for example, matching 401(k) contributions) to attract and retain workers.
• Employer contributions are invested immediately, but the employee does not fully own those contributions until they become vested according to the plan’s schedule.
• Employee contributions to retirement accounts are always fully vested and belong to the employee immediately.
• If a plan is terminated, participants typically become fully vested immediately.

Typical schedule and legal limits

• A common graded vesting schedule spreads vesting over up to six years. A typical example: 20% vested after the initial service period, then an additional 20% each subsequent year until 100% at year six.
• Federal rules set maximum allowable vesting periods (generally six years for many retirement plans), but employers may choose shorter schedules.

Example

If an employer matches 100% of an employee’s contributions up to 7% of salary, an employee earning $75,000 who contributes 7% ($5,250) gets a $5,250 employer match each year. Those employer dollars are invested and grow, but the employee’s ability to keep them if they leave depends on the vesting schedule. Leaving before full vesting can mean forfeiting some employer contributions and earnings.

Exceptions and immediate vesting

• SEP and SIMPLE IRAs: employer contributions are always immediately vested.
• Employee personal contributions: always immediately vested.
• Plan termination: usually triggers immediate vesting for participants.

Why employers use graded vesting

• Retention: Gradual vesting can encourage employees to stay longer, as leaving early may mean losing employer-contributed funds.
• Flexibility: Employers can design schedules that balance competitiveness with cost control.

Considerations for employees

• Know your plan’s vesting schedule before making job changes—quitting before full vesting can mean leaving “free money” behind.
• If you change jobs, consider rolling vested retirement savings into an IRA or new employer plan to preserve tax advantages.
• Ask HR or consult plan documents for specifics about service requirements, initial waiting periods, and how vesting is calculated (calendar-year vs. service-year methods).

Pros and cons

Pros:
– Encourages long-term employment.
– Gives employees partial ownership as they stay.

Cons:
– Employees who leave early may forfeit employer contributions and earnings.
– Can create complexity in financial planning for job transitions.

Takeaway

Graded vesting gradually converts employer contributions into the employee’s property over time. Understanding your employer’s vesting schedule is essential when evaluating job offers, planning career moves, and managing retirement savings.