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Master the Stock Market

Finance FAQ: How Does Vesting Work?

Who hasn’t been in this situation before? Someone throws out a big term, so you nod intently as if you’re following along perfectly. Meanwhile, you’re about as clueless as Kim Kardashian at Mensa. Finance FAQ is all about reducing the number of words that trip you up – starting with “vesting” today. Read on to learn what it means, and how it applies to your retirement accounts and stock options.

esting generally refers to a transfer of ownership from your company to you. It dictates how long you need to work at your company before you can walk away with the perks you’re offered, like 401k contributions or stock options.

Many companies will offer a contribution to your 401k, typically matching a portion of the amount that you contribute yourself. And many tech companies are offering stock options as well (the chance to buy stock in the company at a much cheaper price than the average Joe). Though your company may offer you a contribution up front, it only truly becomes yours to keep after a certain period of time. How long it takes is dictated by your vesting schedule.

For example, your vesting schedule might say that you get to keep 25% of the company’s contribution after a year of working there, 50% after two, and 100% after four years of work. And any amount they contribute after you’re 100% vested is automatically yours to keep. That’s graduated (or graded) vesting. Alternatively, some companies use cliff vesting, which means that if you leave before the time at which you’re 100% vested, you keep nothing.

Let’s test it out with some real numbers. Say you contribute $5,000 a year to your 401k, and your company matches 10% of that ($500 a year). Now let’s say your company’s vesting schedule is 25% a year, for four years. Here’s what you’d get to keep in your 401k depending on when you leave, and depending on what type of vesting schedule your company uses:

  1. Graduated Vesting
  2. Cliff Vesting

The principle works the same way for your stock options if you have them: you’re granted a total number of options up front, and earn the right use them over the period of your vesting schedule.

Do you lose your own contributions if you’re not vested? Vesting only refers to the money your employer contributes to your 401k. You always get to keep 100% of the amount you contribute.

Make sense? Let me know if you have more questions on vesting in the comments

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