Trends in Retirement Plans

Employee Retirement Income Security Act (ERISA)

Qualified and non-qualified plans are differentiated based on the Employee Retirement Income Security Act (ERISA), the federal law that regulates retirement and pension plans within the private sector.

The U.S. Internal Revenue Service and Department of Labor monitor ERISA requirements.

ERISA:

• makes provisions for vesting and participation
• establishes standards for minimum funding
• declares employer responsibilities for fiduciary requirements, disclosure, and reporting

History

During the early 1970s, there was a great deal of concern about retirement plan programs. Many employees who thought they were covered by retirement plans discovered that they weren't.

This was partially an administrative situation (involving very complicated plans) and partially an economic problem (organizations hadn't funded the pension plans and couldn't meet their obligations to retirees).

The failure of so many private retirement plans brought about the Employee Retirement Income Security Act (ERISA), which sets forth the standards that an organization's retirement plan must meet.

ERISA does not say that an organization must have a retirement plan program. However, ERISA does say that if an employer has a retirement plan program, this program must meet certain standards.

Who is eligible?

To be a qualified retirement plan under ERISA, a plan must benefit only employees and their beneficiaries and not discriminate in favor of particular employee groups such as executives.

ERISA has some rules regarding who is eligible to participate in a qualified retirement plan. In general, an employee is eligible if he or she has reached age 21 and has at least 1 year of service with the employer. However, employers may choose to have eligibility requirements that are lower than the federal requirement.

What's the advantage?

Remember, funds contributed to a qualified plan are not counted as income to the employee in that year. Qualified plan contributions are made with before-tax dollars.

When's the employee eligible to receive the funds?

To answer this question, you must understand the concept of vesting.

Vesting	The process by which an employee accrues a non-forfeitable interest in employer provided benefits from a retirement program. Any employee contributions are, of course, always owned by the employee and vest immediately. These benefits cannot be taken away even if the employee quits or is fired.

Q: Why was the vesting requirement included in ERISA?

A: Because organizations would avoid paying retirement plans by letting people go before their retirement age. Plus, having to stay all of one's working life with a particular organization in order to receive a retirement plan drastically reduces labor mobility.

ERISA requires companies to adopt 1 of 2 vesting schedules for defined contribution plans:

1. 3-year cliff vesting. 0% vested for less than 3 years of service; 100% vested after 3 years.
2. 6-year graded vesting. 0% for years 1 to 2; 20% vested after year 2, plus an additional 20% each subsequent year until 100% is vested after 6 years.

Employers can always adopt a more liberal vesting schedule than the statutory requirement, such as immediate vesting.

If an organization automatically enrolls its employees in a 401(k) plan and the plan requires employer contributions, employees vest in those contributions after 2 years.

All employees must be 100% vested by the time they attain normal retirement age under the plan or when the plan is terminated.

Funding requirements

Employers are required to set aside a sufficient amount of funds each year to cover the benefit liabilities that accrued under the plan that year.

For certain types of retirement plans, these accruals can be complex and require the services of an actuary for calculation.

Fiduciary responsibility

Fiduciary	A fiduciary is a person who has a position of trust with respect to any other person. In employee benefit plans, fiduciaries run the plans solely in the interest of participants and beneficiaries for the exclusive purpose of providing benefits and paying plan expenses.

Under ERISA, fiduciaries are obligated to meet a standard of conduct — they must act prudently and must diversify the plan's investments in order to minimize the risk of large losses.

Plus, fiduciaries must follow the terms of plan documents to the extent that the plan terms are consistent with ERISA.

Fiduciaries must also avoid conflicts of interest. In other words, they may not engage in transactions (on behalf of the plan) that benefit parties related to the plan (such as other fiduciaries, services providers or the plan sponsor).

Reporting and disclosure requirements

Plan participants are entitled to receive a summary of the plan. It's called the summary plan description or SPD.

SPD	A written statement of what the retirement plan provides and how it operates in an easy-to-read form. An SPD must include a statement of: eligibility coverage employee rights appeal procedure The company is legally obligated to provide this SPD free of charge to participants, beneficiaries and, upon request, the Department of Labor.

In addition to the summary plan description, the plan administrator must give participants a copy of the plan's summary annual report each year.

The company must also file the annual financial report with the U.S. Department of Labor, using a form called the Form 5500.