The term 'Vested Rights' is included in the Investments edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Choose your edition here...
Vested Rights refers simply to rights that cannot be taken away. In finance, they refer specifically to one of several topics. The most common pertains to employer-provided retirement benefits or stock incentives. They describe the non-forfeitable rights on either employer contributions to the qualified retirement plan or pension plan account or to stock incentives provided as a valuable incentive by the employer. Such vesting will give the employee tangible rights to a portion of the employer-owned assets over time.
This provides a substantial incentive for the employee to deliver his or her best efforts to the company and to stay with it a long time as well. Vesting schedules are always determined by the employing firm. They specify when the employee will then acquire full ownership of the funds, stock, or other asset in question. In general, such non-forfeitable rights will accrue on a time schedule based on the number of years the employee has been with the company.
The amount of time for vested rights to be earned varies from one plan document to the next. It always helps to consider a good example to better understand somewhat complicated topics such as these. An employee could get 100 restricted shares of stock in the firm for which he works as a portion of the yearly bonus. The goal would be to find a way to keep the valuable employee at the firm. The company can do this by spelling out a several year vesting schedule for the stock shares.
For example, it would be common for the stock to vest at the rate of 25 shares (as in 25 percent) per year starting on the completion of the second year. This means that after year three, the employee will be fully vested in 50 shares (50 percent), while after the fourth he or she will have vesting in 75 shares (75 percent), and finally at the end of the fifth year, he or she will entirely own the 100 shares of bonus stock (100 percent vesting). Should the employee part ways with the company at the end of the fourth year, then he or she would have 75 shares of the stock while the remaining 25 would forfeit back to the firm.
There are other benefits where the vested rights are effective immediately. As an example, all employees always gain 100 percent vesting in their own contributions from their salaries to their retirement plans and SIMPLE employer contributions and SEP employer contributions. Generally, any employer contributions to the employee 401(k) plan will also immediately vest. There are other scenarios where this money only vests after a few years on what is called a cliff vesting schedule. This provides the employee ownership of 100 percent of all employer contributions only after completing a pre-determined number of years with the firm. There are also graded vesting schedule options to firms, which mean that the employee gains ownership of a set percentage of all employer contributions made very year. With many traditional pension plans, they will have either a three to seven years long graded vesting schedule, or alternatively a simpler five year cliff vesting schedule built in to their policy.
Becoming one hundred percent vested in an employer retirement plan and employer provided contributions are not a carte blanch to draw out the money on demand though. The rules of the plan will still govern in this regard. They will likely insist that any employees attain legal retirement age before they are allowed to engage in withdrawals without any penalties being assessed.