What is Vesting?

Written by , January 17, 2013

What is VestingAs a general concept, vesting is the process by which an individual gains full ownership and control over a particular financial asset. For example, individuals who are given stock options by their employers must usually wait a certain period of time before they can exercise those options and actually become owners of the stock. Vesting is also an important concept in the context of retirement savings.

What to Know About Vesting. Employer matching funds for 401(k) accounts, as well as company stock options and restricted stock grants, can potentially be very valuable to your portfolio. Do what you can to make sure your employer makes the maximum matching contributions, and issues the maximum stock options and stock grants are available to you.

Here are some common situations where you need to be aware of how vesting works.

  • Basics of Vesting for 401(k) Employer Matching. Most individuals will learn first-hand about vesting because of their employer-sponsored 401(k) plan. Some employers offer a contribution matching component to their 401(k) plans. These employer matches usually take the form of an additional cash contribution, made by the employer directly to the employee’s 401(k) account, based on the amount that the employee contributes to the account themselves. In an effort to increase employee retention, an employer who offers a 401(k) match will often specify that the employee won’t actually be able to keep the employer matched funds unless they remain an employee for a certain amount of time after the employer’s deposit.
  • Stock Options Vesting. The concept of vesting is also important if your employer offers company stock options. A stock option is simply the right to buy company stock at a specified price for a specified period of time. Some companies provide a large amount of stock options to key employees when they begin their employment, although those options will not immediately be exercisable by the employee. Instead, the employee will only be able to exercise a certain number of the options and purchase company stock once they’ve worked at the company for a specified period of time. One common vesting schedule is for a certain percentage of the employee’s initial options to vest after the first year of company service, with the remaining options to vest over time over the course of the next year or two.
  • Restricted Stock Vesting. Vesting is also relevant in the context of an employer who offers company stock to their employees at below market prices, and in the context of employers who allow employees to immediately exercise stock options in order to obtain favorable tax treatment. The concept of restricted stock vesting is similar to that of stock options – you may “own” the stock, but the company has the right to repurchase it back from you unless and until you meet certain restrictions.
  • Stock Resale Restrictions. One common type of restriction is that until you have worked for the employer for a certain number of years, you will be required to sell the stock back to the employer, at whatever price you paid for it, if you leave the company.
  • Most importantly, make sure you understand exactly how your employer’s vesting rules work to maximize your returns.

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