FAQ: Pension Plans and ERISA
Q: What is ERISA?
The Employee Retirement Income Security Act of 1974, or ERISA, protects the assets of millions of Americans so that funds placed in retirement plans during their working lives will be there when they retire.
ERISA is a federal law that sets minimum standards for pension plans in private industry. For example, if an employer maintains a pension plan, ERISA specifies when employees must be allowed to become a participant, how long an employee must work before having a non-forfeitable interest in their pension, how long they can be away from the job before it might affect the benefit, and whether the employee's spouse has a right to part of the pension in the event of the employee's death. Most of the provisions of ERISA are effective for plan years beginning on or after January 1, 1975.
ERISA does not require any employer to establish a pension plan. It only requires that those who establish plans must meet certain minimum standards. The law generally does not specify how much money a participant must be paid as a benefit.
ERISA does the following:
Requires plans to provide participants with information about the plan including important information about plan features and funding. The plan must furnish some information regularly and automatically. Some is available free of charge, some is not.
Sets minimum standards for participation, vesting, benefit accrual and funding. The law defines how long a person may be required to work before becoming eligible to participate in a plan, to accumulate benefits, and to have a non-forfeitable right to those benefits. The law also establishes detailed funding rules that require plan sponsors to provide adequate funding for the plan.
Requires accountability of plan fiduciaries. ERISA generally defines a fiduciary as anyone who exercises discretionary authority or control over a plan's management or assets, including anyone who provides investment advice to the plan. Fiduciaries who do not follow the principles of conduct may be held responsible for restoring losses to the plan.
Gives participants the right to sue for benefits and breaches of fiduciary duty.
Guarantees payment of certain benefits if a defined plan is terminated, through a federally chartered corporation, known as the Pension Benefit Guaranty Corporation.
Q: What are defined benefit and defined contribution pension plans?
Generally speaking, there are two types of pension plans: defined benefit plans and defined contribution plans. A defined benefit plan promises you a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service - for example, 1 percent of an employee's average salary for the last 5 years of employment for every year of service with the employer.
A defined contribution plan, on the other hand, does not promise an employee a specific amount of benefits at retirement. In these plans, the employee and employer (or both) contribute to the individual account under the plan, sometimes at a set rate, such as 5 percent of the employee's earnings annually. These contributions generally are invested on the employee's behalf. The employee will ultimately receive the balance in his or her account, which is based on contributions plus or minus investment gains or losses. The value of the employee's account will fluctuate due to changes in the value of his or her investments. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans. The general rules of ERISA apply to each of these types of plans, but some special rules also apply.
A money purchase pension plan is a plan that requires fixed annual contributions from the employer to the employee's individual account. Because a money purchase pension plan requires these regular contributions, the plan is subject to certain funding and other rules.
Q: What are simplified employee pension plans (SEPs)?
SEPs are relatively uncomplicated retirement savings vehicles that allow employers to make contributions on a tax-favored basis to individual retirement accounts (IRAs) owned by the employees. SEPs are subject to minimal reporting and disclosure requirements.
Under a SEP, the employee must set up an IRA to accept the employer's contributions. As a general rule, the employer can contribute up to 25 percent of the employee's pay into a SEP each year, up to a maximum of $40,000.
Starting January 1, 1997, employers may no longer set up Salary Reduction SEPs. However, the Small Business Job Protection Act of 1996 (Public Law 104-188) permitted employers to establish SIMPLE IRA plans beginning in 1997. A SIMPLE IRA plan allows salary reduction contributions up to $6,000 in 2001 ($7,000 in 2002).
If an employer had a salary reduction SEP in effect on December 31, 1996, the employer may continue to allow salary reduction contributions to the plan. Employees are generally permitted to contribute up to 15 percent of pay, or $10,500 for 2001 ($11,000 for 2002). SEP participants may also be required to earn at least $450 (this number is indexed for inflation) (for 2001) to make salary reduction contributions.
Q: What are 401(k) plans?
A 401(k) plan is a defined contribution plan that is a cash or deferred arrangement. An employee can elect to defer receiving a portion of his or her salary which is instead contributed on the employee's behalf, before taxes, to the 401(k) plan. Sometimes the employer may match the employee's contributions. There are special rules governing the operation of a 401(k) plan. For example, there is a dollar limit on the amount the employee may elect to defer each year. The dollar limit is $11,000. The amount may be adjusted annually by the Treasury Department to reflect changes in the cost of living. Other limits may apply to the amount that may be contributed on the employee's behalf. For example, highly compensated employees may be limited depending on the extent to which rank and file employees participate in the plan. An employer must advise employees of any limits that may apply to them.
Although a 401(k) plan is a retirement plan, an employee may be permitted access to funds in the plan before retirement. For example, an active employee may be able to borrow from the plan. Also, the plan may permit employees to make a withdrawal on account of hardship, generally from the funds he or she contributed. The sponsor may want to encourage participation in the plan, but it cannot make the employee's elective deferrals a condition for the receipt of other benefits, except for matching contributions.
The adoption of 401(k) plans by a state or local government or a tax-exempt organization is limited by law.
Q: What are profit sharing plans or stock bonus plans?
A profit sharing or stock bonus plan is a defined contribution plan under which the plan may provide, or the employer may determine, annually, how much will be contributed to the plan (out of profits or otherwise). The plan contains a formula for allocating to each participant a portion of each annual contribution. A profit sharing plan or stock bonus plan may include a 401(k) plan.
Q: What are employee stock ownership plans (ESOPs)?
Employee stock ownership plans (ESOPs) are a form of defined contribution plan in which the investments are primarily in employer stock. Congress authorized the creation of ESOPs as one method of encouraging employee participation in corporate ownership.
Q: What information is a pension plan required to disclose?
The Employee Retirement Income Security Act (ERISA) requires plan administrators - the people who run plans - to give employees in writing the most important facts they need to know about their pension plan. Some of these facts must be provided to the employee regularly and automatically by the plan administrator. Others are available upon request, free of charge or for copying fees. An employee's request should be made in writing.
One of the most important documents employees are entitled to receive automatically when they become a participant of an ERISA-covered pension plan or a beneficiary receiving benefits under such a plan, is a summary of the plan, called the summary plan description or SPD. A plan administrator is legally obligated to provide to employees, free of charge, the SPD. The SPD is an important document that tells employees what the plan provides and how it operates. It tells employees when they begin to participate in the plan, how service and benefits are calculated, when a benefit becomes vested, when employees will receive payment and in what form, and how to file a claim for benefits. If a plan is changed employees must be informed, either through a revised SPD, or in a separate document, called a summary of material modifications, which also must be given to employees free of charge.
In addition to the SPD, the plan administrator must automatically give employees each year a copy of the plan's summary annual report. This is a summary of the annual financial report that most pension plans must file with the Department of Labor. These reports are filed on government forms called Form 5500 or 5500-C/R.
Q: When must employers deposit withheld employee contributions into a 401(k) plan or other pension plan?
Employers must transmit employee contributions to pension plans as soon as they can reasonably be segregated from the employer's general assets, but not later than the 15th business day of the month immediately after the month in which the contributions either were withheld or received by the employer.
Q: Can a plan be terminated?
Although pension plans must be established with the intention of being continued indefinitely, employers may terminate plans. If a plan terminates or becomes insolvent, ERISA provides employees with some protection. In a tax-qualified plan, accrued benefit must become 100 percent vested immediately upon plan termination, to the extent then funded. If a partial termination occurs in such a plan, for example, if an employer closes a particular plant or division that results in the termination of employment of a substantial portion of plan participants, immediate 100 percent vesting, to the extent funded, also is required for affected employees.
Q: What should I do if I have additional questions about pension plans and ERISA?
While this is a helpful overview of pension plans and ERISA, it's common to have additional questions, especially about your particular situation. If you have questions about your specific situation, it's best to contact a local ERISA attorney who can provide legal advice based on your unique situation.