Understanding your company’s vesting schedule can help you better plan for your financial future.
Many companies offer employee stock options or restricted stock as part of their compensation package or as a reward for meeting performance quotas. When you’re gifted these investment options, however, you may not be able to feel their financial effects right away.
Your investment options will likely follow a vesting schedule in which your stock or retirement plan will “mature” in order for you to exercise your options. Here’s what that means and how it can impact your financial planning.
What Does Vesting Mean?
By definition, vesting is a preset schedule that dictates when employees can take advantage of their stock options. For example, when you receive stock options on your grant date, you can’t exercise those options until they fully vest. Most vesting schedules follow a 3-5 year plan, though the structure can vary by employer.
Employers use vesting schedules as a tool to encourage employees to remain with the company for longer periods of time. When 100 percent of your assets vest, they are yours and cannot be taken away from you for any reason. However, if you leave the company before some stock is fully vested, you may forfeit some of your assets.
Types of Vesting Schedules
Vesting requirements can apply to retirement accounts and stock options alike. Typically, there are three types of vesting schedules:
Immediate vesting schedules have no waiting or time period for employees to leverage their benefits. You immediately have full ownership of the asset.
Graded vesting allows you to receive incremental ownership of the asset over time, which will eventually result in 100 percent ownership of the asset. For example, you might earn 10 percent during the first year, 25 percent during the second year, 25 percent during the third year, and 40 percent during the fourth year. By law, vesting schedules on retirement plans cannot be longer than six years.
Cliff vesting provides a lump sum benefit to the employee at a specified date. For example, in a three-year cliff vesting schedule, you receive no portion of the benefit until you reach three years of employment, at which point you assume 100 percent of the asset.
Examples of Vesting Schedules
Vesting schedules can vary by company, both in terms of duration and the percentage of shares vested each year.
For example, Nike offers its employees a five percent match on their 401(k) contributions, which they vest immediately. There is no waiting schedule or other requirements to take advantage of the match.
Nike also offers restricted stock units (RSUs), which typically vest at 25 percent per year over four years. Once four years have passed from the stock grant date, you can choose to sell the stock immediately or keep it to grow your wealth.
Amazon approaches vesting a little differently. An example taken from a real Amazon job offer shows that company equity (RSUs) doesn’t equally vest each year. Rather, only five percent of the stock will vest during the first year. After year two, 15 percent of the stock units will be vested (or 20 percent total from years one and two). Year three will see a significant increase, where 40 percent of the RSUs will be vested (or 60 percent total from years one, two, and three), and the same will apply for year four, when the RSUs will be 100 percent vested.
Why Does a Vesting Schedule Matter to Stockholders?
When you’re granted stock options that follow a vesting schedule, it’s important to understand how and when you can take advantage of your benefit. Generally, you may not be able to take unvested options with you if you choose to leave the company early, which could severely impact your financial planning.
Using our Amazon example, if you chose to leave the company after two years of receiving your stock options, you’d be leaving 85 percent of your stock behind. In terms of compensation, this could be worth tens of thousands of dollars per year.
For a grant of 50 RSUs valued at $2,000 each, for example, you would only receive $5,000 in stock value after your first year (five percent vested shares). After the second year, your stock value would triple to $15,000, as 15 percent of your shares vest. After year three, you’d add an extra $40,000 to your annual compensation—twice the amount of the previous two years combined!
If you’ve received stock options as part of your compensation, it’s important to understand your company’s vesting schedule. Our certified financial planners can help answer your questions and provide guidance, including tax implications upon vesting.
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