Cliff Vesting - Explained
What is Cliff Vesting of Stock Options?
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Table of ContentsWhat is Cliff Vesting?How does Cliff Vesting Work? The Differences Between Defined Benefit and Defined Contribution PlansAcademic Research on Cliff Vesting
What is Cliff Vesting?
Cliff vesting is a process that qualifies employees to receive full benefits from their employers at a specified time instead of receiving the benefits in bits over a period of time. In most situations, employees receive benefits from the qualified retirement plan of their company after they might have spent an amount of time in the company, the benefits are also received gradually and spread over a period of time. Cliff vesting however allows an employee receive full benefits from qualified retirement plans and pension policies at a specified date after spending years of full time service in the company.
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How does Cliff Vesting Work?
Cliff vesting comes with both advantages and disadvantages, especially for employees. Usually, emerging businesses and startup companies use cliff vesting as a way of attracting competent employees that will add value to the company and stimulate its growth.
Despite that cliff vesting is attractive to employees in the sense that they receive their full benefits from a qualified retirement plan at a specified date rather than receiving it gradually over a period of time, it has some disadvantages. The major disadvantage of cliff vesting for an employee is that is such an employee leaves the company before the specified date, he has forfeited all the benefits. Also, if a startup fails before the vesting date, the benefits might not be received by employees.
The Differences Between Defined Benefit and Defined Contribution Plans
Different companies offer different retirement plans to their employees, the type of retirement plan that a company offers determines how the vesting will work. Let's take defined benefit and defined contribution plans for example.
In a defined benefit plan, an employment pay a specified dollar amount to its former employee annually, the amount is determined by the years of service, last salary and other factors. In a defined contribution plan however, employers contribute to a retirement plan rather than pay to employees. The payment to employees (retirees) vary and is usually determined using the performance of the plan.
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