America is a leader in many things, but I’m not sure they should be proud of pioneering this particular thing. I’m talking about vested interest. (Or sometimes referred to as “golden handcuffs.) Plenty of companies use vested interest as a way to keep their employees from leaving. In some cases, people are delaying their own retirements in an effort to make sure they vest more of their potential compensation. So what exactly is a vested interest?
What Is Vested Interest?
I first learned about vested interest at my first full time job. They handed me all the paperwork I needed to sign up for the company’s 401(k) plan. I was excited about the prospect of saving money and getting that company match. (Yes, I was wired to be a money nerd from a very young age, apparently). However, that excitement faded a bit when they explained that some of the company match would be slowly unlocked, only after I’d worked there for a few years. What a bummer. In hindsight, the company had a fairly decent and reasonable schedule. They offered 20% of the vested interest, fully unlocked and owned by me, for each year of service. So a new employee like myself would have it all within five years. However, it didn’t feel very fair at the time.
In short, a vested interest is some sort of financial reward your employer offers in exchange for years of service. In my case, it was a more generous contributions to my retirement fund. It’s also fairly common for public companies to offer stock options to their employees as vested interest. The schedules vary, but it typically takes somewhere between three-and-ten years to unlock the full package. If you leave the company before you have vested the entire compensation, you only get to keep what you earned to date.
Personal Contributions Are Always Vested
Luckily, the vesting schedule applied only to the company match in my case. That meant that all of my salary contributions to my 401(k) — and all the investment earnings that came from them — were always 100% vested and available to me. When I first started contributing, I simply treated my 6% employer match as 1.2% after one year, 2.4% on both years after two.
It’s important to note that the investment return of the company match is also governed by the same vesting schedule. This means that if the company match is $500 and the 401(k) account earned 10% (or $50), then I get 20%, or $10, after one year. The math can get complicated, but the whole thing is merely a tactic for companies to keep talented employees from jumping ship too soon.
Cliff Vesting vs. Graduated Vesting
There are basically two types of vesting scheduled allowed by the U.S. Department of Labor — cliff vesting and graduated vesting. With cliff vesting, you are 100% vested in your employer’s contribution once you stay with the company for three years. However, none of the funds are technically yours before that date. If you leave your job for any reason, you forfeit the entire vesting compensation.
With graduated vesting, the employer portion is slowly vested to you over time. So it’s not an “all or nothing” approach, like cliff vesting. It might seem like a more reasonable situation on the surface. However, this type of vesting can sometimes actually be the worse option — depending how your employer implements the rules. That’s because the only requirement the Labor Department imposes is that you have to be at least 20% vested once you reach the three-year mark. Then you can vest 20% more each year after that. So instead of being 100% vested in three years under cliff vesting, you might need to wait until six years before all of the 401(k) account balance shown is actually all yours.
Length of the Vesting Schedule
For 401(k) accounts, IRS rules limit the vesting schedule to a maximum of six years. Your retirement plan account will be 100-percent vested at that point. You are also 100% vested by law once you reach normal retirement age under the plan (or if a plan is terminated).
You’ll also be glad to know that the vesting schedule applies to the entire 401(k) account. This means that once you hit six years, every new employer match is immediately vested to you. Otherwise, you could always be handcuffed to stay for another six years, ad infinitum.
This isn’t true with vested interest in stock options though. So let’s talk about those too.
Stock Options Are a Powerful Handcuff
The vesting schedule of stock options may be an even stronger handcuff than 401(k) matches. This is simply due to the enormous size of the compensation and how stocks can increase in value.
In many cases, every tranche of stock options vest at different schedules. In fact, an employee at a company that offers vested stock options typically always has future stock options unlocking eventually. That can keep the worker from ever trying to leave. Some workers even delay their retirement to continue vesting that next chunk of stock awards. The problem is that those “just one more year” justifications tend to keep piling up, seeing workers stay long past their retirement age. It’s the tomorrow that never comes, since “tomorrow is always, well, tomorrow.”
Time Based vs. Other Vesting Schedules
The vesting schedule of 401(k) employer contributions fall under time-based vesting schedules. You reach a certain number of years with the company and the employer match unlocks.
Stock options vesting can be time based too. However, it can also be tied to other milestones. For example, an engineering team may be awarded stock options once their product develops and ships. It can also be performance based. A sales team can be awarded stock options as long as they meet a predetermined sales quota. Even lawyers can be awarded stock options when they can bill enough hours.
Hybrid Schedules Are Also Possible
Unlike the 401(k) vesting schedules, the IRS and Labor Department don’t offer much guidance for stock option vesting. Therefore, any arrangement is theoretically possible. You could even have a hybrid scheme, where a portion of the stock options are vested based on time and another part is vested based on project completion.
When you’re job hunting, make sure to consider your overall compensation package — not just the salary offered. Make sure you understand exactly how the vesting schedule works (and its true financial value) before you commit.
Do Only Tech Jobs Offer Stock Options?
Most people tend to hear about stock options as something that comes along with a job in the tech industry. You’ve probably read stories about long-serving employees of Google, Apple, or Facebook cashing in six- or seven-figure stock options, which have vested over the years. These stories sound great. Who wouldn’t love being awarded $100,000 worth of stock that vests after a project completes, only to have it be worth ten times that amount in five or ten years? That’s an easy million dollar payday, just for not changing jobs.
However, stock options exist in all kinds of settings — not just the tech world. Any publicly traded company can theoretically offer stock compensation to their employees. You can even have stock option package in a small business that isn’t publicly traded (and may never be). It may be called “profit sharing” or even acquiring a small ownership piece of the company.
Vesting Attracts Talent
Speaking of giant compensations due to stock options, look no further than the ones that are given to employees of startups. I remember very well when Facebook IPO’d a few years ago. I participate in an investing forum. There were more than a dozen posts asking for advice from Facebook employees who all of a sudden had tens of millions worth of stock options, once the company decided to make their stock publicly tradeable.
Talk about a big payday! It’s these stories that keep the whole startup industry filled with talent. More recently, there are multiple stories of investors turning an early investment in Coinbase into billions. Heck, a friend of a friend found out his early $20,000 investment in the company is worth $8 million now. It’s safe to say that anyone working at Coinbase for any period of time is plenty rich these days.
Big Risk, Big Reward
On the other hand, these “make you jealous” type of startup stories are actually the outliers. The majority of startups offer employees stock options. However, that often comes with a lower base salary, since the company is just starting up and not likely to be profitable at first. New employees may be attracted to the prospect that their stock options will turn out to be very valuable some day.
However, there’s no guarantee that those stock options will make you rich. Sadly, startups fail all the time. That will render any stock options worthless. Even if a startup is successful, that doesn’t automatically mean the stock options will be worth millions. My friend was working for a startup that successfully IPO’d a few years back. There was a huge celebration, but nobody except a select few employees got anything more than $100,000 in compensation.
Yes, my friend still got a nice little chunk of extra cash. But it’s not like he can retire young or anything. Plus he worked at the company for a below-market base pay, taking the chance that the stock options would make up the difference. They did, so he’s probably coming out slightly ahead. But the money he made through the stock options was hardly life-changing.
Even Crypto Investing Has Vesting
Vesting is even seeping into the cryptocurrency world. There’s a new phenomenon with crypto called yield farming. That’s where investors can invest their cryptocurrencies and earn a yield. With some platforms, developers are compensating investors with the platform’s tokens as added compensation to lure them to try their service.
Right now, you can invest a stable coin like USDC and earn, say, an 8% yield. But if you use certain platforms, then you can get an additional yield because the platform is giving away their token, which you can then sell. Typically, you can sell the platform token right away. Lately, though, developers are locking these reward tokens for a set period of time.
For example, a yield farming platform called Adamant currently rewards investors this way. You get their platform token (ADDY), that’s worth money if you sell it. However, the reward tokens aren’t vested to you until roughly 90 days (give or take a week, since the vesting period are grouped per week) after you earn them. You do earn an additional reward while your ADDYs are vested, at least. Still, you can’t touch the original ADDYs for roughly three months, unless you want to pay a 50% penalty to withdrawal them early.
Double Check the Vesting Schedule Before You Quit
As you can see, vested interest is everywhere from 401(k) plans to stock options and even cryptocurrency. They are all designed to lock you in with the entity that dictated the rules.
When it comes to the vested interest for anything that has to do with your job, it’s very important to figure out the details before you to decide to change jobs or quit. After all, the vesting schedule is very rigid. Quitting just one day early could see your accidently flush a lot of extra compensation down the drain.
The chances of this happening are rare. But still, could you you imagine someone not paying close attention and quitting one day before their Facebook stock options vested? That’s not just giving up your own money, but money that would potentially help your children and grandchildren in the future too.
The Bottom Line
If there’s one piece of advice I have for you, it’s that you shouldn’t let any vested interest dictate your life. I mean, it wouldn’t be smart to change your job if you are literally days (or even weeks) away from a big payday. However, don’t let a future vesting schedule keep you from moving onto greener pastures.
Even worse, don’t ever delay your retirement (when you already have enough saved) just because there are a few more stock options coming your way if you keep grinding. The reality is that there’s always more money to be made if you are willing to trade your time and expertise for it. But more isn’t always better. After all, being chained to any desk forever is bad — even if the handcuffs are made of gold.