4 Trends in Retirement Provisions for Equity Awards

One of the most common questions I’m asked is “What happens to equity awards when employees retire?” The NASPP’s content director, Jenn Namazi, and I recently discussed this exact question in the Equity Expert podcast and I shared data on current practices from the 2021 Equity Incentives Design survey, which is cosponsored by the NASPP and Deloitte Consulting.

Listen to the episode today. To peak your interest, below are highlights from our discussion.

1. There are lots of ways to determine retirement eligibility.

Most companies use a combination of age and service criteria to determine when employees are eligible to retire but there is considerable variation in practice when it comes to how these two criteria are combined.

At 46% of companies, employees must achieve both a minimum age and minimum years of service to be eligible to retire. But this is less than half of companies—the other 54% of respondents are all over the map:

• At 15% of companies, employees can be eligible to retire when they reach A) a minimum age with a specified number of years of service or B) an older minimum age regardless of their years of service. For example, employees might be eligible to retire when they are 50 and have 10 years of service or when they are 55.
• At 14% of companies, employees are eligible to retire when the sum of their age and their years of service equal a specified number (e.g., age + years of service = 70).
• Retirement eligibility is contingent only on age at 13% of companies.

The remaining 12% of companies use a variety of other approaches. Some companies define three eligibility alternatives. For example, employees might be eligible to retire when they A) reach a minimum age and years of service, or B) reach an older age regardless of their years of service, or C) when they’ve achieved a higher number of years of service regardless of their age.

2. Most companies pay out equity awards to retirees.

While the timing and amount of payout can vary, it is very common for companies to pay out at least a portion of all types of equity awards to retirees. Companies are most likely to pay out performance-based awards and least likely to pay out service-based stock options/SARs. Just under 70% of companies pay out service-based awards to retirees, 64% pay out service-based stock options/SARs, and 78% pay out performance-based awards.

The reason more companies pay out performance awards than other types of vehicles is likely because these awards are typically granted only to senior executives, who often receive more generous retirement benefits than lower ranking employees. On the other hand, stock options tend to be granted more by technology companies and less mature companies. These companies often have younger workforces, which may explain why companies are less likely to pay out stock options than other types of equity vehicles.

3. Acceleration is more common for service-based arrangements than performance awards.

When paying out equity awards to retirees, companies must decide between accelerating vesting or allowing awards to continue to vest as originally scheduled. For performance awards, the predominant practice is to pay out the awards to retirees only at the end of the performance period (i.e., continuing vesting).

This allows the company to ensure that retirees receive a payout only to the extent that the performance conditions are met. Otherwise, the performance awards can incentivize the wrong behavior.

Imagine a situation where a company is nearing the end of its performance period and it becomes clear that the performance conditions are not going to be achieved, resulting in the expectation that the awards will be forfeited. Now let’s also imagine a worst-case scenario in which the entire executive team is eligible to retire. If the awards provide for full (or even pro rata) payout immediately upon retirement, the executive team would be incented to retire rather than trying to turn the situation around. That’s not the kind of incentive the board is hoping the performance awards will create!

Acceleration is considerably more common for service-based awards. For full value awards, 33% of companies accelerate vesting and 31% continue vesting. For stock options, 26% accelerate vesting and 36% continue vesting.

My blog entry “Pros and Cons of Accelerating vs. Continuing Vesting Upon Retirement” offers a great rundown of why companies might choose one approach versus the other.

4. Practices are split between pro-rata and full payouts.

Another choice companies face when choosing to pay out equity awards to retirees is whether to pay out awards in full or on a pro-rata basis. When awards are paid on a pro-rata basis, retirees receive a payout that is commensurate with the amount of service they completed before retiring.

We see a fair amount of variation in practice here. For service-based awards, companies are more likely to provide a full payout (48% for options and 42% for full value awards) than a pro-rata payout (14% for options and 22% for full value awards). For performance awards, 41% of companies provide a pro-rata payout and only 31% pay out awards in full.

More Information

Listen to the Equity Expert podcast episode “Trends in Retirement Provisions” for more information, including a summary of how companies treat equity awards in the event of termination due to death and disability.