Cliff Vesting vs Graded Vesting Explained

Cliff vesting is a type of vesting schedule used by employers to grant employees full ownership of benefits, such as stock options or retirement plan contributions, after a specific period of service. With cliff vesting, employees must wait until a particular milestone, usually several years, to become fully vested. For example, if an employee works for a company for 4 years, they may only receive 100% of their benefits after reaching the 4-year mark. If they leave before this milestone, they forfeit the benefits. This schedule is beneficial for employers looking to retain employees for a certain period before rewarding them.

What is graded vesting?

Graded vesting, on the other hand, is a gradual process where employees gain partial ownership of their benefits over time. Instead of waiting for a cliff to be reached, graded vesting gives employees incremental ownership throughout the vesting period. For example, after the first year of employment, an employee might vest 20% of their benefits, 40% after the second year, and so on, until they are fully vested after a set number of years. This type of vesting incentivises employees to stay with the company longer by offering growing benefits each year.

Differences between cliff vesting and graded vesting

Aspect	Cliff vesting	Graded vesting
Vesting schedule	Full vesting at a specific date after a waiting period	Gradual vesting over time, typically in increments
Employee ownership	100% after the cliff period is reached	Partial ownership each year or period
Risk of forfeiture	High risk if employee leaves before the cliff date	Lower risk as benefits are earned over time
Common usage	Stock options, retirement plans with long-term goals	Employer 401(k) matches, other long-term benefits

Examples of cliff vesting and graded vesting

• Cliff vesting example:
• An employee is granted 100 shares of company stock with a cliff vesting schedule. They must remain employed with the company for 4 years before they gain full ownership of all 100 shares. If the employee leaves before the 4-year mark, they forfeit all shares.
• Graded vesting example:
• An employee is granted 100 shares with a graded vesting schedule over 5 years. After the first year, the employee owns 20 shares, 40 shares after the second year, and continues to gain 20 shares each year until fully vested with all 100 shares at the end of 5 years.

For more details on the vesting date meaning and how it impacts your benefits, refer to the linked article on vesting date meaning.

Advantages of cliff vesting

• Clear milestones: Employees receive full benefits at once after a set period, creating a clear incentive to stay with the company.
• Retention tool: One of the possible ways of encouraging employees to remain with the company for a significant period before they can access benefits, reducing turnover.
• Simpler administration: Easier for companies to manage as employees either receive all or none of the benefits.

Disadvantages of cliff vesting

• All-or-nothing: Employees who leave before the vesting date forfeit all benefits, which can be discouraging.
• Delayed rewards: Employees may feel demotivated if they don’t see any incremental benefits over time.
• Potential for loss: Employees might leave just before the vesting date, losing out on all benefits, which could impact morale.

Advantages of graded vesting

• Gradual reward: Employees earn their benefits incrementally, which can motivate them to stay engaged over time.
• Reduced risk for employees: Employees who leave early still retain some benefits, reducing the feeling of losing everything.
• Flexibility: Allows for a more flexible reward structure that can align with long-term employee goals.

Disadvantages of graded vesting

• Complex administration: Tracking incremental benefits over time can be more complex and require more management effort.
• Weaker retention: Since employees can access some benefits earlier, it may not be as strong a retention tool as cliff vesting.
• Reduced sense of milestones: Employees may not feel as strong of an incentive to stay for a long period compared to a cliff vesting schedule.

How to choose the right vesting schedule for your employees

Choosing the right vesting schedule depends on your goals:

• Cliff vesting works well if you want to strongly encourage employees to stay for a certain period.
• Graded vesting is ideal if you want to offer a more gradual and flexible incentive, ensuring employees feel they benefit even if they leave early. You can consider a combination of both to balance flexibility and retention, depending on your employer.

Conclusion:

Both cliff and graded vesting have their advantages and challenges. Choosing the right one depends on your company’s culture, retention goals, and how you want to structure employee benefits. Understanding the strengths and weaknesses of each will help you implement a strategy that supports both your employees and business needs.