What it is:
Graduated vesting occurs when a financial instrument or account becomes wholly owned by an investor over time.
How it works/Example:
Let's assume John Doe is eligible to participate in his company's 401(k) plan. The company match up to $1,000 of his contributions to the retirement plan, but the company's contributions are subject to graduated vesting. This means that although the employer agrees to add extra, free to John's retirement account, that free money doesn't really become his for five years.
So let's say John contributes $1,000 from his paycheck to the plan. His employer, in return, contributes another $1,000 as a match. That match, however, is subject to graduated vesting, so only, say, 20% of that $1,000 "belongs" to John after one . In year two, another 20% of that company match becomes his. The process continues for another three years until 100% of that $1,000 company match officially belongs to John. If John quits his job before that five years ends, he only receives the amount of the match that is vested at the time.
Why it matters:
Graduated vesting is a tactic for encouraging loyalty among employees. However, some employees may feel that graduated vesting within retirement plans is more like a gift that can't be unwrapped for many years.