What is Cliff Vesting?

September 17, 2020

Most companies offer benefits, but on a vested schedule where you earn a percentage of your benefits for each phase of employment. Cliff vesting is different. 

Cliff vesting requires employees to work a specific amount of time (for example 60 months) before they receive any benefits. This eliminates the risk companies take hiring new employees and giving them benefits only to find out they don’t work well for the company.

 

How Cliff Vesting Affects Employees

It’s easy to see from a company standpoint how cliff vesting is beneficial. It cuts out the risk of hiring a ‘bad employee.’ If an employee doesn’t work out or chooses not to say before the cliff period ends, the company never paid out any benefits.

On the employee’s end, though, it’s not as attractive for a few reasons:

  • If you leave the company before you are vested, you walk away with nothing

  • If you are fired before you are vested, you walk away with nothing

  • If the company fails before you’re vested – you walk away with nothing

But, once you are vested, say after 5 years, the benefits are yours. You can take 100% of the funds and roll them over to another 401K, for example, if you leave after 5 years and 6 months. You just have to make it through that vesting period.

 

Two Types of Benefit Plans

Once you know your vesting period, you also need to know the type of plan you’re vested in. There are two main types: 

  • Defined benefit plan – Your employer promises to pay you X amount of dollars per month for the rest of your life upon retirement. You must be vested to receive the funds, but you know how much you’ll receive.

  • Defined contribution plan – The employer may match your contributions up to a certain amount, but there’s no guaranteed dollar amount when you retire. The amount you receive depends on the market and the investment’s performance.

 

Why do Companies use Cliff Vesting?

Employees most commonly use cliff vesting to encourage company loyalty. If they vest employees right away, what incentive do they have to stay? What incentive do they have to perform and ensure they keep their job?

With cliff vesting, there’s an incentive because if the employee doesn’t stay at the company long enough, the years he/she put in won’t be rewarded during retirement. It’s a way to keep employees working hard and for them to stay with the company. This reduces the company’s turnover and therefore their total costs.

Pay close attention to the company’s cliff vesting rules before you start a new job. If you aren’t vested for a while, it’s best to start a retirement fund of your own so you know you’re protected should something happen and you leave the company. Not investing anywhere wastes time, which eliminates the benefit of compound interest that you could be earning if you invested earlier. Don’t give money away by not investing – take advantage of time today.

Rahul Iyer

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