Cliff vesting is the practice of giving one person full ownership of an asset at once, commonly found in retirement and incentive programs and probate law. It provides an incentive for employees to stay on the job and avoid wasted money for employers. Probate law also uses cliff vesting to protect estates and heirs.
Cliff vesting – the practice of giving one person an entire ownership interest in an asset all at once – benefits both the grantor and the recipient of the assets. The concept is most commonly found in employee retirement and incentive programs, as well as probate law. In all cases, however, it provides for the passage of time between the granting of an asset and the full interest of the beneficiary on that asset.
Most Americans are familiar with the concept of vesting as an element of the employer-sponsored retirement savings plans to which they belong. Employees’ ownership interest, or accrual, in their plan contributions is full and immediate. If the employer contributes to the plan, however, the employee usually does not have immediate and complete ownership rights to those contributions. Instead, he has to wait a certain amount of time for the vesting to take place.
Some plans accrue incrementally, so that the employee’s interest increases over time, usually by 20% each year. Others employ cliff vesting: the employee has no interest for a certain period of time, after which they immediately have 100% ownership. The complete and immediately effective change could be compared to the sudden experience of falling off a cliff, hence the term.
The benefits to employers of cliff vesting in retirement plans are clear. Imposing a waiting period upon full accrual provides the employee with an incentive to stay on the job. Another retention incentive kicks in once the employee is acquired; many employees, after going through the waiting period to become matured, would prefer not to have to repeat the experience with another employer.
The alternative to cliff vesting, incremental or gradual, generally starts earlier in a person’s job. After just one year, for example, most plans have a 20% accrual. Therefore, an employee could terminate their employment and walk away with 20% of the employer’s contributions to the retirement plan. From an employer’s point of view, this could be seen as wasted money.
Vesting is also a feature of some employee incentive plans. Many employers grant stock options to their employees, but those options generally cannot be exercised immediately. Some employers provide incremental vesting of options, so that after a certain amount of time the employee has 20% interest, and so on. Other employers grant 100% accrual after a certain period of time, traditionally one year after the initial grant. The better the employer does during that 12-month period, the more valuable the options and the higher the return for the employee.
Probate law also provides for cliff vesting as a way of protecting an estate and its heirs. Many wills bequeath money and assets to heirs and other beneficiaries, but often only to those who are still alive six months after the deceased’s death, which accomplishes two important goals. First, in the event of a disaster that claims the lives of multiple family members, it avoids the problems associated with disputes over who died first. Secondly, it seeks to avoid the transfer of inheritances from one to another and then from a third person, as well as the potential tax consequences. Thus, a person may be named as the beneficiary of a will, but may not be assigned the estate until six months have elapsed, at which point vesting is complete.
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