Employment-based retirement plans
offer significant advantages to employees over the options individuals might
have on their own, with the ability to use otherwise taxable compensation for
the purpose of saving for retirement.
With the amount of assets directed to employer-based retirement
accounts, an important concern is the safe management of those assets and the
ability of employees to understand how those assets are administered. The Employee Retirement Income Security Act
of 1974 (ERISA), along with various provisions of the Internal Revenue Code,
are the primary laws regulating these plans.
This article provides an overview of ERISA and describes how the law
regulates and helps protect employees’ retirement plans.
To understand the scope and importance of ERISA, it is
helpful to consider how private pension plans were regulated prior to its
passage. Tax-favored status of employer-based
retirement plans has deep roots. Early versions of the 1920s era Revenue Acts permitted
employers to deduct pension contributions from income and allowed the funds to
grow tax-free. Over time, the law began
to require certain disclosures and minimum employee coverage requirements. The United State Department of Labor (DOL) eventually
became an overseer of the plans, with legislation intended to prevent abuse and
mismanagement of funds by employers and unions.
Overview of ERISA
Compared to these early laws, ERISA represented an expansion
in enforcement and investigatory powers.
ERISA requires an employer-sponsored plan to meet certain reporting and
disclosure requirements. In addition, it
imposes fiduciary duties upon plan administrators. Finally, it (along with other federal
anti-discrimination laws) bans discrimination in who may participate in the
plans and restricts an employer’s ability to impose eligibility requirements. It is important to note that ERISA does not require that employers offer a
retirement plan. It simply sets forth
minimum standards for such plans and offers remedies when those standards are
violated. Employers that choose to
provide retirement benefits then must comply with ERISA in both the design and
administration of the plans.
ERISA governs most employee-benefit plans that provide for
either retirement income or a deferral of income until after termination of
employment. Retirement plans that meet
the IRS definition of “qualified plans,” such as 401(k)s and traditional
pension plans, are considered employee benefit plans subject to all aspects of
ERISA. Notably, 403(b) plans sponsored
by public education employers, governments and religious organizations are generally
exempt from ERISA. Other “nonqualified” deferred
compensation arrangements, such as plans that are designed only to benefit key
employees, are mostly exempt from ERISA.
The DOL takes a lead role in requiring compliance with
ERISA’s required disclosures, fiduciary responsibilities and bans on prohibited
transactions. An array of causes of
action exist under ERISA, allowing for private civil suits, criminal actions,
civil penalties, sanctions and civil actions by the DOL.
ERISA’s
Requirements for Employer-Sponsored Retirement Plans
ERSIA requires the use of a written plan document to
establish an employee benefit plan. The
document must name one or more fiduciaries who will manage the plan. Plan assets are held in a trust. A system is required to provide plan
documents and information to employees, keep accurate records of funds flowing
to and from the plan and provide for an annual report to the Employee Benefits
Security Administration, a division of the DOL.
This annual report provides detailed information on the assets and
liabilities of the plan.
Determining whether a person or entity is a fiduciary is a
threshold question in assessing whether a breach of a fiduciary duty has
occurred under ERISA. A plan
administrator chosen by the employer, members of a board of directors and
trustees of a retirement plan all may have fiduciary responsibilities to the
plan participants. An employer is
usually the “plan sponsor” who designs the plan, but the employer may also act
as a fiduciary in the implementation and administration of the plan. If an employer hires someone else to provide
fiduciary functions, the employer remains responsible for the choice of the
fiduciary and monitoring the chosen fiduciary.
Determining whether a person or entity has a fiduciary responsibility to
plan participants is a functional inquiry, which is determined by examining
whether the person or entity has discretionary authority to administer or manage
the plan or its assets or provides investment advice for compensation. Fiduciaries have the responsibility to
diversify investments, follow plan documents and act prudently and with sole loyalty
to plan participants. In sum, an ERISA fiduciary must act in the interests of
the plan participants or risk liability.
In addition to actions for breaches of fiduciary duty, plan participants
can also seek remedies for improper denial of benefits and interference with
their rights under ERISA.
Broadly speaking, employer retirement plans are either
defined benefit plans or defined contribution plans. With defined benefit plans, such as a
traditional pension, there is a pre-established level of benefits that the
retired employee will receive and the plan administrator normally has control
over the invested assets. In terms of
investment of employees’ retirement assets, these plans must be fully funded by
the employer. The employer bears the
risk of a decrease in value of invested assets and might be required to make
additional contributions to satisfy its obligations. Further, defined benefit plans must be insured
by Pension Benefit Guaranty Corporation. In addition, ERISA dictates that a plan may
not engage in a “prohibited transaction.”
For example, there are limits on the amount of assets that can be
invested in the securities of the employer. Other prohibitions focus on potential
conflicts of interest or regulating the plan administrator’s ability to engage
in transactions that may be adverse to the interests of plan participants.
Investments in defined contribution plans, such as a 401(k),
are chosen by plan participants. While
plan administrators are not liable for losses in defined contribution plans,
they are still required to provide sufficient information to employees to allow
them to make informed decisions and provide for an array of investments that
allow an employee to choose a diversified investment portfolio. While investment in securities of the employer
are permitted in these plans, guidelines exist to allow employees to divest
themselves of employer securities. Employers
must provide notice to employees to make them aware of when they are entitled
to divest their account of employer securities.
There are also ERISA regulations regarding information that
must be provided to employees regarding their rights and obligations, as wells
as plan expenses and fees. Employers
must provide employees with a Summary Plan Description (SPD). The SPD is a plain-language document
providing detailed information regarding the benefits provided by the plan,
when an employee is eligible to participate, when benefits becomes vested
(owned) by the employee, and the remedies available to an employee.
Employees who are 21 years of age or older and have
completed at least one year of service must be permitted to participate in a
retirement plan if one is offered by the employer. If the plan allows for 100% vesting after two
years of service or less, the plan may extend the years of service requirement
to two years. There are also
restrictions on accrual of benefits that are designed to prohibit age
discrimination in the administration of retirement plans.
Summary
Due to the significant tax benefits offered by
employer-sponsored retirement plans, as well as the societal interest in
ensuring that employees have the opportunity to save for retirement, ERISA has
evolved into a broad tool to regulate such plans and allow for enforcement of
breaches of a fiduciary’s obligation to act in the interest of plan
participants. While the regulatory burden
in complying with its requirements is significant, ERISA offers clear remedies and
access to information for employees participating in employer-sponsored
retirement plans and provides a safeguard against mismanagement of their
retirement savings.
Reprinted with permission from the November 15, 2018 issue of The Legal Intelligencer.
© 2018 ALM Media Properties, LLC. Further duplication without permission is prohibited.
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