You’ve landed a great job with a generous benefits package. However, there's one thing to work out: You need to be fully vested to maximize those benefits.
But what exactly does being vested mean? Which assets can be vested? What are the different vesting schedules you might encounter? And what do you need to keep in mind to get the most out of vesting?
Keep reading to find the answers to all of these questions!
Vesting is the process of earning employer benefits over time following an organization’s chosen vesting schedule. Rather than giving employees access to the entirety of their benefits, employers use vesting to encourage them to stick around and continue to perform at a high level.
To illustrate, let's say an employer offers to match 401k contributions up to 5 percent of an employee’s salary. Under a vesting schedule, the employee who maximizes that benefit might not be able to claim ownership of those matching contributions for a couple of years.
Although the length of vesting schedules varies from company to company, the typical term is 3-5 years. After that time passes, an employee becomes 100 percent vested and owns all the assets.
Most companies that offer vesting do so for their 401k programs. But if you work for a start-up, private company stock and equity might be vested too.
As you start thinking about securing your retirement, remember that not every vesting schedule is the same.Let’s look at four of the most common vesting schedules to give you a better idea of when you can claim full ownership of your benefits.
An immediate vesting schedule means you get your benefits right away. For example, your employer might offer to match your 401k contributions starting on day one and let you keep those matching funds immediately. In most cases, this is the most straightforward and beneficial vesting schedule for employees.
Employers that offer cliff vesting schedules will give you all of the assets you’re entitled to once you reach a particular milestone (e.g., three years of employment). Although your employer might have contributed to a 401k program throughout those three years—and those funds might have appeared on your financial documents—the money doesn’t belong to you until you reach the cliff.
With a graded vesting schedule, you receive benefits at specific intervals. For example, a start-up might offer you 100 shares of pre-IPO stock, and you will receive 20 shares at the end of the year for five years. Graded vesting schedules provide you with a percentage of vested assets over a certain period.
Some employers may opt to combine cliff and graded vesting schedules. To illustrate, you might be offered 100 shares of stock, with 10 shares given at the end of the first year and five shares given every month after until the full 100 shares are transferred.
Now that you have a better idea of what vesting is and what vesting schedules look like, let’s turn our attention to the next piece of the puzzle: how vesting can impact your retirement.
Saving for retirement is no easy feat. In fact, in one recent report, 41 percent of Americans said they face a major uphill battle in saving for their golden years.
If you are offered benefits on a vesting schedule, you must conduct due diligence to ensure you know precisely when you can expect ownership of those assets. After all, the last thing you want is to incorporate vested assets into your retirement plans only to learn they’re not yours yet—or you left a job too early to fully vest your benefits.
If the goal is long-term financial security and comfortable retirement, ensure you’re 100 percent vested before you leave the job.
You might think vesting sounds too complicated, to the point that it’s not even worth getting involved. Although vesting might introduce more variables into your retirement plan, you should still take full advantage of vesting programs.
Let’s say your employer offers to match up to 6 percent of your salary in a 401k program. The benefits vest on a graded schedule, so you won’t have access to the employer’s matching funds for three years.
Even so, putting 6 percent of your salary into your 401k is a shrewd move. Not only can you lower your current tax obligations by funding your 401k with pre-tax dollars, but you can also increase the size of your account by maximizing your employer benefits. Of course, you must stay at the job for three years to become fully vested.
As you refine your retirement plans, consider the impact vesting schedules might have on your life. What happens if you realize you don’t like your job after one year, but you need to stay there for four years to become fully vested? Even if you like the job, some major life changes might convince you to accelerate your retirement, causing you to rethink whether it’s worth it to stick around.
Additionally, consider the potential tax implications of vested assets. For example, if your employer offers restricted stock units on a vesting schedule, you will have to pay ordinary income taxes on those securities when the vesting period ends.
Companies use vesting schedules to encourage employees to work hard for a long time and attract new workers. Rather than having to pay out all benefits at once, vesting enables companies to extend their cash flow by paying benefits out over a longer period (and perhaps even keep some assets that aren’t fully vested).
Some companies opt to reward their employees with phantom stocks instead of actual shares of stock. These shares aren’t “real,” but they move with the company’s share price and allow them to reward employees without diluting ownership. When employees sell these shares, they have to pay income taxes (versus capital gains taxes for real shares).
Vesting schedules can help you secure a healthier financial futureand there is no rule that says you have to navigate it on your own.
If you’re struggling with vesting schedules, EP Wealth Advisors can help. Contact us today to learn more about how we can work together to build a retirement plan that helps you meet your goals. You can also click here to access our free on-demand webinar recording on “Optimizing Employee Benefits.”
The EP Wealth Advisors financial planning process starts with the relationship between you and your financial advisor. How do you value a financial coach? Developing a partnership that ensures we understand your goals lets us help you prioritize and organize your financial decisions—so you can achieve peace of mind and live your life.
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