Vesting requirements are often imposed on employer contributions and
associated account balances in a Nonqualified Deferral Plan (NQDP).
Vesting requirements are a commonly-used strategy to retain key employees.
Vesting gives the participant a non-forfeitable right to his account balances
derived from employer contributions over a certain period of time. The
period of time for full vesting (i.e., the time at which a participant
may leave the employ of the company with the right to 100% of his account
balances) may vary from 100% vesting immediately, to a percentage of the
account balance vesting each year. Years, for vesting purposes, are usually
measured in one of two ways:
- Years of Service
- Years of Plan Participation
Years may be based on completed years or nearest years. Participants
in a plan that bases its vesting schedule on completed years must
remain with the company through the anniversary date of their date of
hire or their date of participation in order to be fully vested for that
Completed Years Vesting Example:
Mr. Jones is a participant in a NQDP which measures its vesting years
by years of service. Mr. Jones was hired by the company on June 6, 1990,
and decides to leave the company 5 years later on May 12, 1995. Because
Mr. Jones left before his years of service anniversary date, he will only
be credited with 4 years of vesting.
Participants in a plan that uses a nearest years vesting schedule would
be credited with the current year's worth of vesting once they complete
more than 50% of that vesting year.
Nearest Years Vesting Example:
Ms. Smith is an executive in a NQDP using a years of plan participation
vesting schedule. Ms. Smith joined the plan on June 6, 1990, then leaves
the company 5 years later on April 3, 1995. She would be credited with
a full five years of vesting since she remained in the plan for more than
50% of that vesting year.
Participants are always 100% vested on account balances associated
with their own deferrals.
Common patterns (schedules) of vesting include:
- Full and Immediate Vesting - All account balances vest
- Graded Vesting - A percentage of the account balance vests
each year. An example of a graded vesting schedule would be 20% per
year for 5 years.
- Cliff Vesting - Full vesting occurs after a specified number
of years, with no partial vesting at all
Class Year Vesting
Class Year Vesting , in essence, treats each calendar year of deferral
as a separate entity.
Class year vesting results in each calendar year's deferrals vesting
separately, according to the vesting schedule selected. For example, assume
that a graded vesting schedule of 20% per year was applied on a class
year basis. Then the following would occur:
- Year 2000 deferral account balances
would be 20% vested in year 2000, 40% vested in year 2001,
60% in year 2002, etc.
- Year 2001deferral account balances would be 20% vested in year 2001,
40% vested in year 2002, etc.
Choosing an Appropriate Vesting Schedule
A sponsor may choose any vesting schedule. There are no statutory
requirements for a NQDP.
Here are some practical considerations:
- Full and immediate vesting is obviously the choice that will achieve
the most satisfaction with plan participants. However, it will also accelerate
the corporate liability growth.
It is also the simplest form of
vesting to use when considering the new FICA and FUTA
withholding rules. The new rules require FICA withholding
on the portion of the employer account balance that vests each year.
Once taxed for FICA purposes, any future growth on that portion of
the balance escapes future FICA tax. Any graded vesting schedule will
require a complex record keeping system to keep track of what
portions have already been taxed.
- Cliff vesting provides the slowest
growth rate of corporate liability, but results in a spike
at the end of the cliff period. It also simplifies the
calculation of FICA/FUTA taxes as stated above.
- The major benefit of class year vesting is the minimization of the
rate of corporate liability growth. For any given schedule other than
full and immediate vesting, class year vesting will increase liabilities
at a slower rate than the same schedule utilized without the class year