Vesting Schedules

A vesting schedule is a table of time periods and percentages. It indicates the percentage of value that a participant in a phantom stock plan would receive upon a separation of service or certain other triggering events.

For example, consider a single grant of 100 units given at the beginning of year 1 of a plan. The plan agreement might state that the participant will be fully vested in three years, with no partial vesting. The vesting schedule for this grant would be as follows:

Years from Date of GrantPercentage Vested
1 0%
2 0%
3 100%

It should be noted that the sponsor is not required to establish a vesting schedule for its grants. Though uncommon, this would be referred to as immediate vesting.

The issues to consider when deciding on a vesting schedule include:

  • What period of years will constitute the full vesting period?
  • How shall vesting build over the period?
  • From what date will the vesting period commence?
  • What end-date will be used for vesting?
  • Will vesting be “graded” or be tied to “class years”?
  • What events would result in accelerated vesting?

Each of these questions is discussed below.


Common Vesting Approaches

The most common choices for vesting periods are three, four or five years. The sponsor may choose any vesting period.

If the period is relatively short (i.e., 3 years), “cliff vesting” is often used. The example used above involves cliff vesting (no incremental build-up). However, many 3-year schedules build incrementally (0%, 50%, 100% or 1/3, 1/3, 1/3). Four or five year schedules typically will build incrementally, e.g., 25% per year over four years or 20% per year over five.

Vesting Commencement Dates

The plan agreement should state the day on which vesting begins. Most commonly this would be the first day of the plan year. Otherwise, it may be the day of grant or may even be tied to the participant’s employment date.

Vesting Anniversary Date

Typically, each vesting period will conclude one-year from the vesting commencement date. For example, units for which vesting began on May 1 would reach their first vesting anniversary on April 30 of the following year.

In many plans, grants may be awarded during the year (e.g., May 1) but have a vesting commencement date of January 1 (assuming a calendar year plan). In this case the vesting anniversary date would typically be January 1.

The plan sponsor has the flexibility of tying vesting achievement to plan year dates, grant dates or any other date that will help it achieve the plan purposes.

Graded vs. Class Year Vesting

The graded vs. class-year decision relates to how one thinks about the full group of all shares granted over a period of years. Graded vesting would treat the value of all the shares equally. Class year vesting would treat each year’s grants differently.

Assume a graded schedule of 20% per year over five years. At the end of the fifth year, all shares awarded to the participant (whether granted in year one or year five) would be fully vested.

Now assume a class year schedule of 20% per year. In this case, each year’s grants would be subject to the five-year schedule.

Class year vesting extends each grant out over a new vesting schedule. Graded vesting arrives at a specific date by which all shares are vested.

It is popular to utilize class year vesting together with a set period of years when all shares would become fully vested. For example, a plan might use a four year class year vesting schedule and then state that all shares would be fully vested following ten years of plan participation.

Accelerated Vesting

Suppose a company or participant experiences an unplanned event prior to the completion of a vesting schedule. This event might be the employee’s death, or disability, or the sale of the company. When drafting the plan, the sponsor may choose to “accelerate” vesting in order to give the participant (or beneficiary) the benefit of the full value of the award.

The law provides some allowance for deferring the decision about acceleration of vesting until the time the event occurs. However, it is considered a best practice to make these decisions in advance and express them in the plan document.