FAQ: Pension Plans and ERISA
What is ERISA?
The Employee Retirement Income Security Act of 1974 (ERISA) protects the retirement assets of American workers. It sets minimum standards for pension plans offered by private-sector employers. The standards ERISA sets include the following:
- How long you must work before you have a "non-forfeitable" interest in your pension
- Whether your spouse has a right to claim at least some of your pension when you die
The law doesn't compel businesses to provide a pension. But companies that do must meet ERISA's standards. Generally, ERISA doesn't dictate how much money should be put into a pension plan.
What are defined benefit and defined contribution pension plans?
There are generally two kinds of retirement plans. The first is the defined benefit plan. This plan promises you a specific amount at retirement, which you can receive in a lump sum or an annuity. If you choose the annuity, you will receive a monthly payment until you die. The plan may state this promised benefit as an exact dollar amount. But what is more common is that the plan will calculate a benefit through a plan formula that considers factors such as salary and years of service.
The second kind of retirement plan is the defined contribution plan. This plan doesn't promise a specific benefit amount at retirement. Instead, you, your employer, or both contribute to your account under the plan. Sometimes the rate is a particular rate, such as 5 percent of your annual earnings. The value of your account fluctuates according to changes in the value of your investments. Examples of defined contribution plans include the following:
The general rules of ERISA apply to each of these types of plans. But some special rules may apply also.
What are simplified employee pension plans (SEPs)?
SEPs are simple retirement savings arrangements. They allow employers to contribute to an employee's individual retirement account (IRA). The employer contributions are tax-favored. Self-employed individuals can also use a SEP to contribute to a retirement plan.
Under a SEP, you set up an IRA to accept employer contributions. Your employer's contributions cannot exceed the lesser of 25 percent of your pay or a pre-defined maximum. The pre-defined maximum amount changes by year. It's $61,000 in 2022 and $66,000 in 2023.
A salary reduction SEP (SARSEP) is a type of SEP the IRS discontinued in 1997. An employer with a SARSEP in effect on December 31, 1996, may continue to allow contributions to the plan. Employees are generally permitted to contribute up to 25 percent of their pay.
What are 401(k) plans?
A 401(k) plan is a defined contribution plan. You can elect to defer part of your salary and have it contributed to the 401(k) on your behalf. Your contribution is before taxes. Sometimes the employer will match your contributions. The 401(k) is subject to specific rules, such as a dollar limit on the amount you may defer each year. Other limitations may apply to the amount your employer can contribute. Your employer must advise of these limits.
Although a 401(k) plan is for retirement, you may access these funds before retirement under certain conditions. For example, your plan may permit you to withdraw some amount due to a hardship (generally from the funds you contributed).
The law limits the adoption of 401(k) plans by state or local governments or tax-exempt organizations.
What are profit-sharing plans or stock bonus plans?
A profit-sharing or stock bonus plan is a defined contribution plan. Under these plans, your employer may determine how much it will contribute to the plan annually. Such plans contain a formula for allocating part of each annual contribution to each participant. A profit-sharing or stock bonus plan may include a 401(k) plan.
What are employee stock ownership plans (ESOPs)?
Employee stock ownership plans (ESOPs) are defined contribution plans. In an ESOP, the investments are primarily in employer stock. Congress authorized the creation of ESOPs to encourage employee participation in corporate ownership.
What is your pension plan required to disclose?
ERISA requires plan administrators to give you essential information about your pension plan. The administrator must automatically provide this information on a regular basis. Other information is available to you on written request.
A summary of the plan, called the summary plan description or SPD, is one of the most important documents to which you're entitled. The SPD tells you the following:
- What the plan provides, and how it operates
- When you begin to participate in the plan
- How your plan calculates your service and benefits
- When your benefit becomes vested
- When you will receive payment, and in what form
- How to file a claim for benefits
Your administrator must tell you if your plan changes. It can do so either through a revised SPD or in a separate document called a summary of material modifications.
The administrator also must give you a copy of your plan's summary annual report at no cost. To learn more about your plan's assets, ask the plan administrator for a copy of the full annual report.
How long do employees have to wait to become members of a pension plan and to become vested in their benefits?
Eligibility and vesting requirements vary by plan. For eligibility, plans generally require you to have a specific tenure with your employer before you can take part. At least one year of service is a common requirement.
The term "vesting" means the employee has earned a non-forfeitable right to benefits funded by employer contributions (employees always have a non-forfeitable right to their contributions). Think of vesting as another term for ownership. When you are vested, you own and can keep the funds your employer contributed to the plan on your behalf.
There is a variety of vesting schedules. Your plan can allow for immediate vesting. It can also allow for 100 percent vesting after several years of service, such as 100 percent vesting after three years of service.
Your plan can also have a graduated vesting schedule where you vest at a specific rate each year. For example, you can vest 20 percent the first year and another 20 percent each year until you are 100 percent vested.
What protections do ERISA's fiduciary rules provide?
ERISA protects your plan from mismanagement and misuse of assets through its fiduciary provisions. A plan fiduciary is anyone who exercises any discretion or control over the plan's administration. Examples include the following:
- Plan trustees
- Plan administrators
- Members of a plan's investment committee
A fiduciary's primary duty is to run the plan solely in the interest of participants and beneficiaries. They also must administer the plan for the exclusive purpose of providing benefits and paying plan expenses.
Fiduciaries must avoid conflicts on behalf of the plan that benefits parties related to the plan. For example, they should not run the plan to benefit:
- Other fiduciaries
- Service providers
- The plan sponsor
A fiduciary who breaches their duty may be personally liable for restoring any losses to the plan caused by their acts. They may also have to pay back any profits they made through improper use of plan assets. A court can take whatever action is appropriate, including removing the fiduciary.
When must employers deposit withheld employee contributions into a 401(k) or another pension plan?
ERISA has rules governing when employers must transmit employee contributions to pension plans. The employer must do so as soon as they can reasonably segregate the funds from their general assets. But they must send it before the 15th business day of the month following the month in which the contributions were either withheld or received by the employer.
When can you choose your own investments?
A group or an individual makes all the investment decisions in some defined contribution plans. But other defined contribution plans will provide you with several different investment options. You will then decide how to invest your funds.
Under Department of Labor rules, fiduciaries do not have a duty if you exercise independent control of your investments. This type of plan is a 404(c) plan, named after section 404(c) of ERISA. You are responsible for your investment decisions' consequences when participating in a 404(c). That means plan officials are not liable for any investment outcomes.
The plan administrator of a 404(c) must inform you that they do not have fiduciary duties over investments in the plan. A 404(c) plan also must give you adequate information about investment options under the plan so you can make informed decisions.
When may your plan permit you to take payment?
The limitations on distributions vary depending on the type of pension plan. So, consult your summary plan description for the specifics about receiving your benefits.
Your plan may require a waiting period before you can receive a distribution. The waiting period allows the plan to calculate your benefit and determine your payment schedule. It may also have to value your account balance and liquidate your investments.
If your plan is a defined benefit plan, it will set a normal retirement age. These types of plans may permit earlier payments such as when you:
- End your employment
- Suffer a disability
The plan may establish additional eligibility requirements for early retirement.
If your plan is a 401(k) plan, you may be able to take some or all your vested accrued benefit in specific circumstances. For example, when you:
- End your employment
- Become disabled
- Suffer a hardship
If your plan is a profit-sharing or stock bonus plan, you may be able to receive your vested accrued benefit after you:
- End your employment
- Become disabled
- Reach a specific age
You may also receive your benefit after a specific number of years have passed.
How do you make a claim for benefits?
ERISA requires all plans to have a reasonable written procedure for processing claims. It must also have a process to appeal a denial of a claim. The summary plan description contains a description of these procedures.
If the plan denies your claim, it must notify you in writing. It must give you the reason it denied your claim and the specific plan provisions on which it based the denial. The plan must generally give you this information within 90 days.
The plan may deny your claim because the administrator needs more information. In that case, the plan must tell you what information the administrator needs. Any notice of denial must also tell you how to file an appeal.
The plan must give you at least 60 days to appeal any denial. After receiving your appeal, the plan generally must issue a ruling within 60 days. If the plan notifies you that it must hold a hearing or has other special circumstances, it may have 60 more days.
When the plan has reviewed your appeal, it must give you a final decision. It must include the reasons for the decision with references to the relevant plan documents. If you disagree with the final decision, you may file a lawsuit seeking your benefit under ERISA. You must complete all the steps available to you under the claims procedure before seeking relief through the courts.
When should participants expect to receive distributions from their pension plans after termination?
Generally, the law requires plans to begin paying retirement benefits within 60 days of the end of the plan year in which you:
- Reach the normal retirement age, usually 65
- Participate in the plan for ten years
- Terminate service with your employer
But many plans -- including 401(k) plans --provide for earlier payments under certain circumstances. The plan's SPD should explain the plan's rules for obtaining the distribution. It should also explain the timing of any distributions after the termination of employment.
What happens to your benefits upon death?
ERISA provides some protection to the spouses of deceased participants who had earned a vested pension benefit. This protection depends on the type of plan. Whether the participant dies before or after the annuity starts is a factor as well. The annuity start date is the date when the pension benefit payment begins. Check your plan's SPD for details.
What is a qualified joint and survivor annuity (QJSA)?
A qualified joint and survivor annuity (QJSA) is an annuity paid to a surviving spouse in a defined benefit plan. The QJSA must be a series of equal, periodic payments over your lifetime. This recurring payment must be at least 50 percent (not more than 100 percent) of the recurring payment received during your joint lives. The payment continues to your spouse for the rest of their life if they survive you.
You and your spouse can waive your rights to receive the QJSA if your plan provides other forms of benefit payment. Following are the rules to do so:
- You and your spouse must receive an explanation of the QJSA
- You must make the waiver in writing within certain time limits
- Your spouse must provide consent to the waiver in writing
Can your pension be attached for family support?
In general, creditors cannot take your pension benefits. But there is an exception when family support is at stake. A state court can issue a qualified domestic relations order, which the plan must honor. This order awards all or part of your pension benefit to an alternate payee such as your:
- Former spouse
- Other dependent
The court's order can be in the form of any of the following:
- State court judgment
- Decree or order
- Court-approved property settlement agreement
Can a plan be terminated?
Employers may indeed terminate plans. If your plan terminates or becomes insolvent, ERISA provides you with some protection. In a tax-qualified plan, your accrued benefit must be 100 percent vested immediately when the plan ends. If there's a partial termination, you become 100 percent vested to the extent funded. For example, when your employer closes a plant and lays off a substantial portion of plan participants.
Can I get my pension money if I'm laid off?
If you're enrolled in a defined contribution plan, you may be able to get a lump sum payment when you leave the company. Examples of a defined contribution plan are a 401(k) or a profit-sharing plan.
But if you're enrolled in a defined benefit plan, your benefits begin at retirement age. These plans are less likely to contain a provision that enables you to withdraw money early.
Some plans only permit distribution once you reach a specified age. Other plans only allow distribution once you have been separated from employment for a particular time. Some plans process distributions throughout the year, and others only process them once a year. You should contact your plan administrator for more information about your pension distributions.
In addition to the SPD, your employer may give you an individual benefit statement showing the value of your pension benefits. The value of your pension benefit is the amount you have earned to date and your vesting status. You can also request this statement. These documents contain important information, whether you withdraw your money now or later.
Is my plan required to give me a lump-sum distribution?
ERISA does not require pension and profit-sharing plans to provide for lump-sum distributions. Lump-sum distributions are possible only if the plan specifically provides for them. You must meet the plan's eligibility requirements for a lump sum payment.
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