Vesting

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on August 10, 2023

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What Is Vesting?

Vesting is a process through which an individual earns the right to own a benefit or asset over time.

In the context of employee benefits, the vesting period refers to the time an employee must work for an employer before they can take full ownership of the benefits offered.

This means that during the vesting period, an employee may not have full access to the benefits or may be subject to restrictions on how to use them.

The length of the vesting period varies depending on the type of benefit or asset in question. For example, an employee stock option may have a vesting period of two years, while a retirement plan may have a vesting period of five years.

Generally, vesting periods can range from a few months to several years.

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Importance of Vesting for Employees

Vesting periods are an essential component of employee benefits. Employees may receive various types of benefits, such as stock options, retirement plans, and other equity incentives.

Vesting periods are important for employees because they ensure that they have a stake in the company's success. They ensure that employees work for a certain amount of time before taking full ownership of these benefits.

When employees are given equity incentives with vesting periods, they are more likely to stay with the company and work towards its success.

Vesting periods can motivate employees to work towards specific goals or objectives, especially when the vesting is tied to performance criteria.

Employee vesting periods can also help employers retain top talent. When employees are given equity incentives with vesting periods. They are more likely to stay with the company and work towards its success.

This can help employers retain their top performers and reduce turnover rates.

Importance of Vesting for Employers

Employers use vesting periods to create fair and competitive employee compensation packages. Vesting schedules can help employers retain top talent and incentivize employees to work towards specific goals or objectives.

Vesting periods are essential for employers because they help attract and retain top talent. When employers offer fair and competitive compensation packages with vesting periods, they are more likely to attract and retain their top performers.

Vesting periods also incentivize employees to work towards specific goals or objectives, which helps improve company performance.

Types of Vesting Periods

There are two main types of vesting periods: time-based vesting and performance-based vesting.

Time-Based Vesting

Time-based vesting refers to a vesting period that is based on a fixed period of time. This means that an employee must work for a certain amount of time before they can take full ownership of the benefit or asset.

Time-based vesting is the most common type of vesting period and is used for various employee benefits such as stock options, retirement plans, and other equity incentives.

For example, let us say that an employee is granted stock options with a vesting period of two years. If the stock option has a total grant of 100 shares, the employee may receive 25 shares after one year of service and the remaining 75 shares after two years of service.

During the vesting period, the employee may be unable to sell or transfer the shares.

One advantage of time-based vesting is that it is straightforward and easy to understand. Employees know exactly when they will receive their benefits, and employers can easily manage the vesting process.

However, one disadvantage of time-based vesting is that it may not incentivize employees to work towards specific goals or objectives.

Performance-Based Vesting

Performance-based vesting refers to a vesting period based on achieving certain performance criteria. This means that an employee must meet certain performance goals or milestones before they can take full ownership of the benefit or asset.

Performance-based vesting often incentivizes employees to work towards specific goals or objectives.

For example, an employee is granted stock options with a performance-based vesting period of three years. If the performance criteria are met, the employee may receive 50% of the shares after two years and the remaining 50% of the shares after three years.

One advantage of performance-based vesting is that it incentivizes employees to work towards specific goals or objectives. This can help improve employee motivation and productivity.

However, one disadvantage of performance-based vesting is that it may be more difficult to manage and track compared to time-based vesting.

Types of Vesting Period

Legal Implications of Vesting Periods

Vesting periods have legal implications that employers, employees, and investors must be aware of.

Legal professionals can help ensure that vesting schedules comply with legal requirements and help resolve any disputes that may arise.

Tax Implications

Vesting periods have tax implications that employers, employees, and investors must be aware of.

For example, when an employee exercises stock options, they may be subject to ordinary income tax on the difference between the strike price and the stock's market price.

Similarly, when an employee receives RSUs, they may be subject to ordinary income tax on the stock's fair market value.

Regulatory Compliance

Vesting periods are subject to various regulations, including tax laws, securities laws, and other regulations that govern employee benefits. Employers, employees, and investors must ensure their vesting schedules comply with these regulations to avoid legal penalties.

Contractual Agreements

Employers and employees must negotiate and draft fair vesting agreements that comply with legal requirements. Vesting agreements should clearly define the vesting period and any restrictions on using the benefits or assets.

Legal professionals can help employers and employees draft and enforce vesting agreements and help resolve any disputes that may arise.

Conclusion

In conclusion, vesting periods are essential to employee benefits and equity incentives. They ensure that employees work for a certain amount of time before they can fully own the benefits or assets granted to them.

Vesting periods motivate employees to work towards specific goals or objectives and help employers attract and retain top talent.

Investors use vesting periods to evaluate the potential impact of equity incentives on company performance, while legal professionals ensure that vesting schedules comply with legal requirements.

Understanding vesting periods is essential for employees, employers, investors, and legal professionals alike.

Given the complexity and importance of vesting periods, it is advisable to consult a financial advisor who can help individuals and organizations navigate these issues.

A financial advisor can provide valuable guidance on retirement planning, tax implications, and legal requirements, helping individuals and organizations make informed decisions that align with their long-term financial goals.

Vesting FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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