in terms of benefits.
if vesting period for a benefit is 2 years,
does it mean you start earning the benefit the day you join but you lose it if you leave before 2 years?
or does it mean your benefit starts after 2 years or service meaning you deduct 2 years from your years of service?
It can have slightly different meanings for different assets, but generally it means the time until the asset ownership and rights are 100% transfered to you.
For example, with stock grants, if they have a vesting period of 3 years, you have to wait 3 years before the asset is truly yours. If you quit before before 3-years, they may not give you the full stock grant.
For stock options, a vesting period of 3 years may mean you cannot exercise the options for 3 years.
Vesting periods are further incentives for employees to stick with a company. Why quit now when your in-the-money options will vest in 3 years and will be worth $10 / option?
It’s funny that you ask this. In 2010 I found myself in Frankfurt, Germany, teaching a 5-day Level II review course that I had not planned (nor for which I was fully prepared) to teach: I got stuck in Zürich when the volcano in Iceland erupted, and David Hetherington, who was supposed to teach the class, couldn’t fly from New York to Frankfurt.
About mid-afternoon on the second day I was teaching FRA and covering the vested benefit obligation (VBO) in pension plans when a hand rose the the back of the room. “What does ‘vested’ mean?”
It was at that moment that we established a new rule in class: if I ever use a word that they don’t understand, they’re to stop me and insist that I define it. They could fail the exam simply because they didn’t know one definition.
Back to “vesting”: sometimes the employee doesn’t gain the full ownership immediately of the pension benefits he earns; he gains that ownership over a period of time. That gradual gain of ownership is known as vesting, and is often (though not always) a linear function of time. So if the benefits vest (linearly) over a period of two years, then if the employee leaves after, say, 1½ years, then he gets only 75% (= 1½ ÷ 2) of the pension benefits that have accrued in his account; the remaining 25% reverts to the company.
A longer vesting period is seen as a means to instill loyalty in the workforce.
I see… so when calculating the obligation, we don’t exclude vesting period… because although ownership is not transfered, he has started earning it… Correct?
thank you!
Correct.
You’re welcome.
Hi, may i know what happen if the vesting period is changed? Would there be an actuarial gain/ loss? Thank you.
doesn’t affect actuarial g/l
It depends on whether there is a change in prior service costs or not.
For example, if the vesting period changes from 5 years (at 20% per year) to 4 years and you’re two years into it, they may make it 25% per year, so there would be a prior period service cost, or they may make it 20%, 20%, 30%, 30%, so there isn’t.
Thanks BigCheese & S2000magician. 