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Employee Retirement Income Security Act

EMPLOYEE RETIREMENT INCOME SECURITY ACT

The Employee Retirement Income Security Act (ERISA) was signed into law by President Gerald Ford on Labor Day, 2 September 1974. This landmark law provides extensive rules governing private pension plans and other employee benefit plans. The primary function of ERISA has been to help ensure greater retirement security for those American workers who have pensions. ERISA has largely achieved this result by (1) requiring that private pension plans hold plan assets in trust for the benefit of the employees and their beneficiaries, (2) requiring that pension plans be funded on a timely basis, and (3) ensuring that most covered employees with more than five years of service have a vested (i.e., nonforfeitable) right to receive their pension benefits.

It is important to note that the United States has a voluntary pension system. Private employers are not required to have pensions, but if they do, ERISA is applicable. Since it was enacted, ERISA has been amended numerous times, and a whole regulatory system has grown up to enforce its provisions. The key agencies charged with the administration of ERISA are the U.S. Department of Labor, the Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corporation (PBGC).

From 1975 until 1995, the total number of private tax-qualified retirement plans rose from 311,000 to 693,000, and the total number of plan participants (including workers, retirees, and survivors) rose from 45 million to 87 million. In 1995, these plans held more than $2.7 billion in assets.

Private pension-plan participation and coverage are by no means universal, however. In 1993, for example, only 44 percent of U.S. civilian workers participated in a private pension plan, and only about 38 percent were vested. The government has long been interested in expanding private retirement-plan coverage, and this concern has motivated many of the changes to ERISA.

History leading up to ERISA

Pensions are a relatively modern phenomenon. Prior to 1900, few employers provided pensions to their employees, and there was little legislation to govern the pension plans that did exist. Private pension-plan growth was slow until after World War II, and the pace of pension legislation has paralleled the growth of the private pension system.

Tax legislation was the earliest mechanism for regulating private pension plans. For example, the Revenue Acts of 1921 and 1926 allowed employers to deduct pension-plan contributions from corporate income; they allowed for pension-fund income to accumulate tax-free; and they provided that participants would not be taxed until pensions were distributed to them. To qualify for favorable tax treatment, however, pension plans had to meet certain minimum requirements pertaining to employee coverage and employer contributions. The Revenue Act of 1942 imposed stricter participation requirements and, for the first time, disclosure requirements.

During and after World War II, pension coverage expanded greatly, as did reports of mismanagement and abuse of pension funds. For example, Jimmy Hoffa, the leader of the International Brotherhood of Teamsters, was alleged to have abused his union's Central and Southern States Pension Fund. The need for government regulation of private pensions culminated in the passage of the Welfare and Pension Plans Disclosure Act (WPPDA) in 1959. The WPPDA required plan sponsors (e.g., employers and labor unions) to file plan descriptions and annual financial reports with the Department of Labor, and these materials were also made available to plan participants and beneficiaries. The WPPDA was amended in 1962 to give the Department of Labor additional enforcement, interpretive, and investigatory powers over employee benefit plans. The WPPDA had a very limited scope, and eventually it was replaced by ERISA's much more comprehensive system for pension regulation.

One of the seminal events leading up to the passage of ERISA was the December 1963 shutdown of the Studebaker automobile company in South Bend, Indiana. Studebaker had promised its employees generous retirement benefits, but it had never adequately funded its plan. Consequently, the Studebaker plan was able to pay full retirement benefits only to its 3,600 retirees and to those active workers who had reached the permitted retirement age of sixty, while the company's remaining 7,000 workers were left with little or nothing to show for their years of work.

In the 1960s, Congress held numerous hearings on private pension plans, but reform came slowly. U.S. Senator Jacob K. Javits (R-New York) introduced the first broad-scale pension reform bill in 1967. This bill ultimately became the Employee Retirement Income Security Act of 1974 (ERISA), which was designed to secure the benefits of participants in private pension plans through participation, vesting, funding, reporting, and disclosure rules, and through the establishment of the Pension Benefit Guaranty Corporation.

The administration of ERISA is divided among the Department of Labor's Pension and Welfare Benefits Administration (PWBA), the Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corporation (PBGC). Title I of ERISA, which contains rules for reporting and disclosure, vesting, participation, funding, fiduciary conduct, and civil enforcement, is administered primarily by the PWBA. Title II of ERISA, which amended the Internal Revenue Code to parallel many of the Title I rules, is administered by the IRS. Title III of ERISA is concerned with jurisdictional matters and with coordination of enforcement and regulatory activities by the PWBA and the IRS. Finally, Title IV covers the insurance of defined-benefit pension plans, and it is administered by the PBGC.

Subsequent amendments to ERISA

Since its enactment in 1974, ERISA has been amended many times to help meet the changing retirement and health care needs of employees and their families. The Retirement Equity Act of 1984 addressed a broad variety of women's issues. The act reduced the maximum age that an employer may require for participation in a pension plan from twenty-five to twenty-one; lengthened the period of time a participant could be absent from work without losing pension credits; and created spousal rights to pension benefits through a qualified domestic relations order (QDRO) in the event of divorce, and through preretirement survivor annuities.

The Tax Reform Act of 1986 established faster minimum vesting schedules and mandated broader coverage of rank-and-file workers. The Older Workers Benefit Protection Act of 1990 amended the Age Discrimination in Employment Act (ADEA) to apply to employee benefits.

With respect to health care plans, the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) added a new part 6 to Title I of ERISA that provides for the continuation of health care coverage for employees and their beneficiaries (for a limited period of time) if certain events would otherwise result in a reduction in benefits. More recently, the Health Insurance Portability and Accountability Act of 1996 (HIPAA) added a new Part 7 to Title I of ERISA aimed at making health care coverage more portable and secure for employees.

Types of ERISA-covered retirement plans

Most private retirement plans are governed by ERISA, and they typically qualify for favorable tax treatment. Basically, an employer's contributions to a tax-qualified retirement plan on behalf of an employee are not taxable to the employee. Nevertheless, the employer is allowed a current deduction for those contributions (within limits). Moreover, the pension fund's earnings on those contributions are tax-exempt. Workers pay tax only when they receive distributions of their pension benefits, and at that point the usual rules for taxing annuities apply.

Private retirement plans generally fall into two broad categories, based on the nature of the benefits provided: (1) defined benefit plans and (2) defined contribution plans. In a defined benefit plan, an employer promises employees a specific benefit at retirement. To provide this benefit, the employer makes payments into a trust fund and makes withdrawals from the trust fund. Employer contributions are based on actuarial valuations, and the employer bears all of the investment risks and responsibilities. Benefits are guaranteed by the Pension Benefit Guaranty Corporation.

Under a typical defined contribution plan, the employer simply contributes a specified percentage of the worker's compensation to an individual investment account for the worker. For example, contributions might be set at 10 percent of annual compensation. The benefit at retirement would be based on all such contributions plus investment earnings. There are a variety of different types of defined contribution plans, including money purchase pension plans, target benefit plans, profit-sharing plans, stock bonus plans, and employee stock ownership plans (ESOPs).

Profit-sharing and stock bonus plans may include a feature that allows workers to choose between receiving cash currently or deferring taxation by placing the money in a retirement account (401(k) plans or cash or deferred arrangements (CODAs)). The maximum annual amount of elective deferrals that can be made by an individual in the year 2001 is $11,000, and it is scheduled to rise to $15,000 in 2006.

Alternatively, many companies rely on hybrid retirement plans that mix the features of both defined benefit and defined contribution plans. Still another approach is for an employer to offer a combination of defined benefit and defined contribution plans. For example, many companies with traditional defined benefit plans have recently added supplemental 401(k) plans.

The major requirements of ERISA

ERISA does not require employers to provide benefits to their employess, but if an employer chooses to have a plan, ERISA regulates that plan. ERISA requires that an employee benefit plan be established and maintained by an employer. The plan must be in writing, and it must be communicated to employees. The plan must be operated for the exclusive benefit of employees or their beneficiaries, and ERISA generally requires that plan assets be held in a trust.

To protect the interests of plan participants, ERISA requires significant reporting and disclosure in the administration and operation of employee benefit plans. For example, a typical pension plan will have to file reports with the IRS and the Department of Labor, and it will have to provide a summary plan description and a summary annual report to each participant.

In addition, ERISA imposes significant participation, coverage, vesting, benefit accrual, and funding requirements on private retirement plans. For example, a retirement plan generally may not require, as a condition of participation, that an employee complete a period of service extending beyond either age twenty-one or one year of service. Also, a plan may not exclude employees from participation just because they have reached a certain age (e.g., age sixty-five). Employees can be excluded for other reasons, however. For example, a plan might be able to cover only those employees working at a particular location or in a particular job category. Under the minimum coverage rules, however, a retirement plan must usually cover a significant percentage of the employer's work force. Alternatively, a plan may be able to satisfy the minimum coverage rules if it benefits a certain class of employees, as long as it does not discriminate in favor of the employer's highly compensated employees.

Retirement plans must also meet certain minimum vesting requirements. A worker's retirement benefit is said to be vested when the worker has a nonforfeitable right to receive the benefit. For example, under the five-year cliff-vesting schedule, an employee who has completed at least five years of service must have a nonforfeitable right to 100 percent of his or her accrued benefit. Alternatively, under three-to-seven-year graded vesting, an employee must have a nonforfeitable right to 20 percent of her or his accrued benefit after three years of service, 40 percent after four years of service, and so on up to 100 percent after seven years of service. These are minimum vesting requirements, and a plan is free to use a faster vesting schedule, or even to provide for immediate vesting.

ERISA also imposes rules on how benefits accrue under retirement plans. These rules help ensure that retirement benefits accrue at certain minimum rates, and they keep employers from skewing ("backloading") benefits in favor of their long-service employees. For example, each plan must comply with at least one of three alternative minimum-benefit accrual rules. Under the so-called 3 percent rule, for example, a worker must accrue, for each year of participation (up to 33 and 1/3 years) at least 3 percent of the normal retirement benefit that would be received if she or he stayed with the employer until age sixty-five.

Retirement plans must also meet certain minimum funding standards. These rules help ensure that the money needed to pay the promised benefits is set aside in a trust fund where it can earn income until it is used to pay benefits when the employee retires. ERISA also imposes extensive fiduciary responsibilities on employers and administrators of employee benefit plans. These parties in interest must manage the plan for the exclusive benefit of workers and their beneficiaries, and they must act prudently, diversify plan investments, and follow the plan provisions. Failure to meet these responsibilities is a breach of duty that can result in personal liability.

In addition, ERISA's prohibited-transaction rules prevent parties in interest from engaging in certain transactions with the plan. For example, an employer usually cannot sell, exchange, or lease any property to the plan. A person who participates in a prohibited transaction is subject to a 15 percent excise tax, which is increased to 100 percent unless the transaction is reversed.

Title IV of ERISA created the Pension Benefit Guaranty Corporation (PBGC) and a plan-termination insurance program. Defined benefit plans generally pay annual termination insurance premiums to the PBGC. In the event an underfunded plan terminates (e.g., because the employer went out of business), the PBGC will guarantee payment of pension benefits to the participants (up to a maximum limit, in the year 2001, of $40,705 per year, per participant).

ERISA also provides for various judicial remedies. For example, plan participants or beneficiaries can sue plans and plan administrators to recover benefits, enforce rights, or clarify future rights to plan benefits. ERISA also permits the secretary of labor to bring lawsuits to enforce ERISA's fiduciary responsibility rules.

One of the central objectives of ERISA was to federalize pension and employee-benefit law. In particular, Section 514 provides that the provisions of Titles I and IV of ERISA "shall supersede any and all State laws as they may now or hereafter relate to any employee benefit plan." The courts have generally interpreted this preemption language broadly; for example, to prevent states from requiring ERISA-covered health care plans to provide specific benefits (i.e., chiropractic or psychiatric benefits). Similarly, the courts have relied on this language to prevent plaintiffs from bringing state tort and tort-related causes of action against employee benefit plans.

Retirement savings not covered by ERISA

ERISA covers employment-based private retirement plans (and health care plans). It does not apply to government plans such as Social Security or a state teachers retirement system. State and local government plans are, however, subject to many of the usual tax qualification rules in the Internal Revenue Code, but these plans are not subject to the minimum funding rules, nor are they required to pay premiums to insure their plans with the BGC.

Favorable tax rules are also available for certain individual retirement accounts (IRAs). Almost any worker can set up an IRA account with a bank or other financial institution and contribute up to a specified maximum amount per year to that account. Workers who are not covered by another retirement plan usually can deduct their IRA contributions. If a worker is covered by another retirement plan however, the deduction may be reduced or eliminated if the worker's income exceeds $33,000 for a single taxpayer or $53,000 for married taxpayers (in the year 2001). Like private pensions, IRA earnings are tax-exempt, and distributions are taxable.

Since 1998, individuals have also been permitted to set up so-called Roth IRAs. Unlike regular IRAs, contributions to Roth IRAs are not tax-deductible. Instead, withdrawals are tax-free. Like regular IRAs, however, the earnings of these IRAs are tax-exempt.

Pension coverage

Even though Americans have a greater and greater need for additional retirement savings, pension coverage remains far from universal. Even among workers between forty and sixty years of age, only 60 percent are covered by a pension plan (as of 1999). While 71.6 percent of employees at medium- and large-size private firms (100 or more employees) participated in a pension plan in 1997, only 37.3 percent of workers at smaller firms participated in a plan that year. Also, there is a particularly large gender gap concerning private pension income. In 1995, 46.4 percent of men over age sixty-five received pension and/or annuity income (averaging $11,460 per year), but only 26.4 percent of women over age sixty-five that year received a pension or annuity, and these averaged just $6,684 per year.

The future of ERISA

Over the years, there have been a number of proposals to expand participation in employer-sponsored pensions. In particular, many analysts have suggested shortening the vesting period, promoting pension-plan portability, and increasing participation (e.g., by covering part-time workers). Another alternative would be to allow designated financial institutions to administer defined contribution megaplans for numerous small employers. Employers would contribute to these megaplans, each employee would have her or his own account, and the financial institution would take on all of the reporting, disclosure, and fiduciary responsibilities.

Another approach would be to mandate private pensions. Depending upon the size of the program, this approach could compel most workers to set aside a large enough share of their earnings over their careers to fund adequate retirement benefits. For example, in 1981, the President's Commission on Pension Policy recommended adoption of a Mandatory Universal Pension System (MUPS). Basically, the proposal would have required all employers to contribute at least 3 percent of wages to private pensions for their workers. The proposal drew little interest at the time. Recently, however, there has been renewed interest in mandated pensions.

One design for a mandatory pension system would be to piggyback a system of individual retirement savings accounts (IRSAs) onto the existing Social Security withholding system. For example, both employers and employees could each be required to contribute 1.5 percent of payroll to these IRSAs (and the self-employed would be required to contribute the entire 3 percent). These accounts could be held by the government, invested in secure equity funds, and annuitized on retirement. Alternatively, these individual accounts could be held by financial institutions and their investment could be directed by individual workers.

A different approach would be for the government to mandate that employers provide a suitable defined benefit plan for their employees. In that regard, the government might authorize employers to use a central clearinghouse where employers could send pension contributions on behalf of their employees. Over the course of a career, each worker would earn entitlement to a defined benefit that, at retirement, would supplement Social Security.

Jonathan Barry Forman

See also Economic Well-Being; Employee Health Insurance; Federal Agencies and Aging; Pensions: Financing and Regulation; Pensions: History; Pensions: Plan Types and Policy Approaches; Retirement Planning.

BIBLIOGRAPHY

Bernstein, M. C. The Future of Private Pensions. New York: Free Press, 1964.

Committee for Economic Development. New Opportunities for Older Workers: A Statement on National Policy by the Research and Policy Committee of the Committee for Economic Development. New York: Committee for Economic Development, 1999.

Conison, J. Employee Benefit Plans in a Nutshell. 2d ed. St. Paul, Minn.: West Publishing Co., 1998.

Costa, D. L. The Evolution of Retirement: An American Economic History, 18801990. Chicago: University of Chicago Press, 1998.

Council of Economic Advisors. "Annual Report of the Council of Economic Advisors." In Economic Report of the President. Washington, D.C.: Government Printing Office, 1999. Pages 7454.

Eisenberg, D. "The Big Pension Swap; Accounts That Yield Benefits Sooner Are Replacing Traditional Plans, but Older Workers Are Crying Foul." Time 19 April 1999, p. 36. Employee Benefit Research Institute. EBRI Data-book on Employee Benefits, 4th ed. Washington, D.C.: Employee Benefit Research Institute, 1997.

Employee Retirement Income Security Act of 1974, Public Law No. 93-406, 88 Statutes at Large 829 (1974) (codified as amended in scattered sections of Titles 26 and 29 of the United States Code).

Forman, J. B. "Universal Pensions." Chapman Law Review 2 (1999): 95131.

President's Commission on Pension Policy. Coming of Age: Toward a National Retirement Income Policy. Washington, D.C.: President's Commission on Pension Policy, 1981.

Sass, S. A. The Promise of Private Pensions: The First Hundred Years. Cambridge, Mass.: Harvard University Press, 1997.

Steuerle, C. E., and Bakija, J. M. Retooling Social Security For The 21st Century: Right & Wrong Approaches To Reform. Washington, D.C.: Urban Institute Press, 1994.

U.S. Congress, Joint Committee on Taxation. Overview of Present-Law Tax Rules and Issues Relating to Employer-Sponsored Retirement Plans. Report No. JCX-16-99. Washington, D.C.: Joint Committee on Taxation, 1999.

U.S. Congress, Staff of the House Committee on Ways and Means. 1998 Green Book: Background Material and Date on Programs within the Jurisdiction of the Committee on Ways and Means, 105th Congress, 2d Session. Committee Print No. WMCP: 105107. Washington, D.C.: U.S. Government Printing Office, 1998.

U.S. Department of Labor. PWBA History and ERISA. 2000. Available on the World Wide Web at http://www.dol.gov/dol/pwba/public/aboutpwba/history4.htm

U.S. General Accounting Office. Implications of Demographic Trends for Social Security and Pension Reform. Report No. GAO/HEHS-97-81. Washington, D.C.: U.S. Government Printing Office, 1997.

World Bank. Averting the Old-Age Crisis. Oxford: Oxford University Press, 1994.

Yakoboski, P. "Overview of the U.S. Employment-Based Retirement Income System." In The Future of Private Retirement Plans. Edited by Dallas A. Salisbury. Washington, D.C.: Employee Benefits Research Institute, 2000. Pages 1937.

Zelinsky, E. A. "ERISA and the Emergence of the Defined Contribution Society." In Proceedings of the Fifty-Seventh New York University Institute on Federal TaxationEmployee Benefits and Executive Compensation. Edited by Alvin D. Lurie. New York: Matthew Bender, 1999. Pages 6-1 and 6-29.

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Employee Retirement Income Security Act (ERISA)

Employee Retirement Income Security Act (ERISA)

The Employee Retirement Income Security Act of 1974 (ERISA) is a U.S. federal law that regulates most private sector employee benefit plans, including 401(k) plans, profit-sharing plans, simplified employee pension (SEP) plans, and Keogh plans. Originally intended to address the problem of embezzlement from plan funds by trustees, ERISA sets minimum standards to ensure that such plans are established and maintained in a fair and financially sound manner. The law obligates employers to provide plan participants with the benefits they are promised, and establishes strict penalties for those who fail to do so. It also sets forth vesting requirementstime periods over which employees gain full rights to the money invested by employers on their behalf. ERISA governs most employer-sponsored pension plans, but does not apply to those sponsored by businesses with less than 25 employees.

ERISA outlines a number of requirements for administrators of employee benefit plans. For example, those who manage plan funds are required to manage them in the exclusive interest of plan participants and beneficiaries. In other words, employers are not allowed to use retirement funds set aside by employees for their own purposes. ERISA also requires plan administrators to avoid transactions that would create a conflict of interest, and to respect limitations on the percentage of employee benefit plan funds that can be invested in employer securities.

ERISA also sets rules governing the disclosure of information about the financial condition of benefit plans to participants and to the U.S. government. For example, administrators are required to furnish participants with a summary plan description (SPD) covering their rights and benefits under the plan. In addition, employers must file Form 5500 annually with the Internal Revenue Service to report the financial condition and other information about the operation of the plan. ERISA provides for civil and criminal penalties of up to $1000 per day for failing or refusing to comply with these annual reporting requirements.

In 1996 the Health Insurance Portability and Accountability Act (HIPAA) amended ERISA to improve the continuity of health insurance coverage for employees who terminate their employment with a company. The amendment prohibits employers from discriminating against employees on the basis of health status and sets rules regarding preexisting conditions.

The Consolidated Omnibus Budget Reconciliation Act (COBRA), initially passed in 1985 but amended in 1999 and most recently in 2004 also enhanced the provisions of ERISA. The COBRA provisions enable workers to continue health coverage after losing their jobs and other specified conditions. For more detail, see this volume under Consolidated Omnibus Budget Reconciliation Act (COBRA).

For more information about the provisions of ERISA, see the Department of Labor Web site at http://www.dol.gov.

see also Pension Plans; Consolidated Omnibus Budget Reconciliation Act (COBRA)

BIBLIOGRAPHY

Bates, Steve. "Benefits Experts Welcome Final COBRA Rules." HRMagazine. July 2004.

Clifford, Lee. "Getting Over the Hump before You're Over the Hill." Fortune. 14 August 2000.

"DOL Releases Final COBRA Notice Rule." HR Focus. September 2004.

Infante, Victor D. "Retirement Plan Trends." Workforce. November 2000.

Lynn, Jacquelyn. "Request Denied? Protect employees from a health insurance loophole." Entrepreneur. March 2006.

Szabo, Joan. "Pension Tension." Entrepreneur. November 2000.

U.S. Department of Labor. "Health Plans & Benefits." Available from http://www.dol.gov/dol/topic/health-plans/erisa.htm. Retrieved on 4 March 2006.

U.S. Small Business Administration. Anastasio, Susan. Small Business Insurance and Risk Management Guide. n.d.

                                  Hillstrom, Northern Lights

                                 updated by Magee, ECDI

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Employee Retirement Income Security Act

EMPLOYEE RETIREMENT INCOME SECURITY ACT

The Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C.A. § 1001 et seq. (1974), is a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals enrolled in these plans. ERISA regulates the financing, vesting, and administration of pension plans for workers in private business and industry. The 1974 enactment of ERISA by Congress was intended to preserve and protect the rights of employees to their pensions upon retirement by establishing statutory requirements that govern such matters.

ERISA requires retirement plans to provide participants with information including important details about plan features and funding. ERISA also describes fiduciary responsibilities for those who manage and control plan assets, requires plans to establish a grievance and appeals process for participants seeking benefits from their plans, and gives participants the right to sue for benefits and breaches of fiduciary duty. A number of amendments to ERISA expand the protections that are available to health-benefit-plan participants and beneficiaries. One important amendment, the Consolidated Omnibus Budget Reconciliation Act (COBRA), 29 U.S.C. §§ 1161–1168 (1994), provides some workers and their families with the right to continue their health coverage for a limited time after certain life events, such as the loss of a job. Another amendment to ERISA, the Health Insurance Portability and Accountability Act (HIPAA), 29 U.S.C. §§ 1181–1182, provides important new protection for working Americans and their families who have preexisting medical conditions or who might otherwise suffer discrimination in health coverage based on factors related to health. Other important amendments include the Newborns' and Mothers' Health Protection Act, the Mental Health Parity Act, and the Women's Health and Cancer Rights Act. In general, ERISA does not cover group health plans established or maintained by government entities, churches, or plans that are maintained solely to comply with applicable workers compensation, unemployment, or disability laws. ERISA also does not cover plans maintained outside the United States primarily for the benefit of non-resident aliens or unfunded excess benefit plans.

cross-references

Employment Law.

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