Topic 4.7: Employee Retirement Income Security Act
Congress passed the Employee Retirement Income Security Act (ERISA) in 1974 in response to growing concern for the protection of worker pension plans. At that time, it was increasingly evident that employers did not have sufficient funds available to meet their pension obligations. The purpose of ERISA is to encourage cautious and careful management of retirement funds by employers.
ERISA applies to all employee benefit plans, defined as “any plan, fund, or program established or maintained for the purpose of providing medical, surgical, or hospital care or benefits in the event of sickness, accident, death or unemployment or vacation benefits.” ERISA does not protect welfare benefits.
ERISA protects two types of plans—defined benefits and defined contributions. Defined contribution plans are those in which the amount of the contribution by each employee is set and the employee merely receives whatever amount (principal and interest) is in the account at the time of retirement. Defined benefit plans are those in which the amount the employee is to receive at retirement is set at the time the employee enters the plan. It is similar to an annuity.
Eligibility and Vesting Rules
ERISA requires that all individuals age 21 or over who have completed one year of work must be covered by their employer’s pension plan. An employee’s right to his or her interest in a plan is considered vested (acquiring rights) after 3 years and must be 100 percent and nonforfeitable by 7 years. However, the employee may not have access to the money until retirement.
Fiduciary Duties, Reporting, and Disclosure Requirements
ERISA establishes specific requirements (or fiduciary duties) that each plan coordinator (or fiduciary) must follow. Fiduciaries are held to a high standard of loyalty to the fund participants and are obligated to act first and foremost in the best interests of the fund.
Fiduciaries are directed to manage the fund “with the care, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.” In other words, they are to act with reasonable care.
In 1985, Congress created the Consolidated Omnibus Budget Reconciliation Act (COBRA) that set the standards for retrieval (withdrawal) of funds by pension managers. Before an employer can terminate a plan, the employer must purchase a fully funded annuity for the plan beneficiaries who have already retired and create a new plan with adequate funds to meet the existing obligations for current employees.
If the employee is legally terminated or otherwise loses the right to benefits, COBRA requires the employer to extend employee health insurance coverage for up to 18 months at the rates originally charged.
ERISA also specifies:
· diversification of fund portfolios
· a prohibition on conflicts of interest
· employee access to information concerning the plan
Employers must fund the normal costs of the plan each year and amortize their employees’ liabilities from previous service over no more than 40 years, and from the formation of new plans over 30 years. They must also purchase insurance from the Pension Benefits Guarantee Corporation (PBGC) to cover potential losses if a plan terminates. Pensions for retired workers must be insured at 100 percent while those of current workers must be insured at the level vested at the time of termination.
The Department of Labor enforces ERISA issues related to disclosure requirements. The Internal Revenue Service enforces issues related to vesting and funding requirements.
An individual may file an action under ERISA. In addition, there is an antiretaliation clause. Employers have the right to reduce or modify employee benefits as long as similarly situated participants are treated alike.
Ask Yourself
Review Questions
1. True or false: ERISA does not protect retirement plans against misfeasance by plan trustees.
2. If the amount an employee puts into a pension plan is specified, but the amount paid out in benefits is not, the employee is:
a. enrolled in a defined benefit plan.
b. enrolled in a defined welfare plan.
c. eligible for PBGC protection.
d. enrolled in a defined contribution plan.
3. Distinguish between pension benefits and welfare benefits.
