Regulation of 401(k) Plans Under ERISA

The Employee Retirement Income Security Act of 1974, or ERISA, protects the assets of millions of Americans so that funds placed in retirement plans during their working lives will be there when they retire.

ERISA is a federal law that sets minimum standards for 401k pension plans in private industry.  For example, if an employer maintains a 401k pension plan, ERISA specifies when an employee must be allowed to become a participant, how long they have to work before they have a non-forfeitable interest in their 401k pension, how long a participant can be away from their job before it might affect their benefit, and whether their spouse has a right to part of their 401k pension in the event of their death.  Most of the provisions of ERISA are effective for plan years beginning on or after January 1, 1975.

ERISA does not require any employer to establish a 401k pension plan.  It only requires that those who establish plans must meet certain minimum standards.  The law generally does not specify how much money a participant must be paid as a benefit.

According to Southern California-based (401k) Enginuity (www.401kenginuity.com), twenty-year veteran in developing and running 401(k) administration and 401(k) software and recordkeeping systems, the Internet will be the primary delivery system for 401(k)s by 2007. Many web-based 401(k) plans will run on administration and recordkeeping platforms that plan providers will outsource to 401k specialists and 401k Application Service Providers (ASP).

The advantages of web-based online 401(k) plans are obvious to today's workers, and include use conveniences, real-time monitoring and reporting, and instant re-allocation of their retirement assets. The internet has also dramatically reduce the cost of 401(k) plan administration, saving plan sponsor 50% or more in ongoing fees and costs when compared to the older traditional labor-intensive plans. Outsourcing of 401(k) functions by plan providers will extend the trend towards lower cost, high-quality 401(k) products.

401(k) plan providers of all types, financial institutions including banks, insurance companies, brokerages, mutual fund companies, credit unions, and third-party administrators, are now actively outsourcing 401(k) administration and recordkeeping tasks to 401(k) ASPs --- vendors such as 401k Enginuity, whose sole function is to maintain, updated and supervise software-based 401(k) administration and recordkeeping systems on behalf of plan providers. 401(k) ASP vendors are responsible for all routine day-to-day 401(k) recordkeeping and administration functions, thus allowing the plan providers to reduce internal staff, eliminate the expense and complications of licensing, housing and running hardware and 401(k) administration software in-house. Plan providers can refocus and concentrate their efforts on to the needs of their plan sponsors and plan participants, and rely upon the outsourced ASP 401(k) vendor for the recordkeeping and technical "backbone" supporting providers' Internet-based plans. It is inevitable that some of this 401(k) outsourcing to ASPs will include secondary outsourcing of certain non-critical low-level routine day-to-day tasks to non-US locations, where labor costs are less yet the expertise is abundant.

ERISA does the following:

Requires plans to provide participants with information about the plan including important information about plan features and funding.  The plan must furnish some information regularly and automatically.  Some is available free of charge, some is not.

Sets minimum standards for participation, vesting, benefit accrual and funding.  The law defines how long a person may be required to work before becoming eligible to participate in a plan, to accumulate benefits, and to have a non-forfeitable right to those benefits.  The law also establishes detailed funding rules that require plan sponsors to provide adequate funding for your plan.

Requires accountability of plan fiduciaries.  ERISA generally defines a fiduciary as anyone who exercises discretionary authority or control over a plan's management or assets, including anyone who provides investment advice to the plan.  Fiduciaries who do not follow the principles of conduct may be held responsible for restoring losses to the plan.

Gives participants the right to sue for benefits and breaches of fiduciary duty.

Guarantees payment of certain benefits if a defined plan is terminated, through a federally chartered corporation, known as the Pension Benefit Guaranty Corporation.

What are defined benefit and defined contribution 401k pension plans?

Generally speaking, there are two types of pension plans: defined benefit plans and defined contribution plans.  A defined benefit plan promises participants a specified monthly benefit at retirement.  The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement.  Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service - for example, 1 percent of average salary for the last 5 years of employment for every year of service with an employer.

A defined contribution plan, on the other hand, does not promise a specific amount of benefits at retirement.  In these plans, the participant or the employer (or both) contribute to the participant's individual account under the plan, sometimes at a set rate, such as 5 percent of their earnings annually.  These contributions generally are invested on the participant's behalf.  The participant will ultimately receive the balance in their account, which is based on contributions plus or minus investment gains or losses.  The value of the account will fluctuate due to changes in the value of investments.  Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans.  The general rules of ERISA apply to each of these types of plans, but some special rules also apply.

A money purchase pension plan is a plan that requires fixed annual contributions from an employer to a participant's individual account.  Because a money purchase pension plan requires these regular contributions, the plan is subject to certain funding and other rules.

What are simplified employee pension plans (SEPs)?

An employer may sponsor a simplified employee pension plan or SEP.  SEPs are relatively uncomplicated retirement savings vehicles.  A SEP allows employers to make contributions on a tax-favored basis to individual retirement accounts (IRAs) owned by the employees.  SEPs are subject to minimal reporting and disclosure requirements.

Under a SEP, the employee must set up an IRA to accept the employer's contributions.  As a general rule, the employer can contribute up to 25 percent of the employee's pay into a SEP each year, up to a maximum of $40,000.

Starting January 1, 1997, employers may no longer set up Salary Reduction SEPs.  However, the Small Business Job Protection Act of 1996 (Public Law 104-188) permitted employers to establish SIMPLE IRA plans beginning in 1997.  A SIMPLE IRA plan allows salary reduction contributions up to $6,000 in 2001 ($7,000 in 2002).

If an employer had a salary reduction SEP in effect on December 31, 1996, the employer may continue to allow salary reduction contributions to the plan.  Employees are generally permitted to contribute up to 15 percent of pay, or $10,500 for 2001 ($11,000 for 2002).  SEP participants may also be required to earn at least $450 (this number is indexed for inflation) (for 2001) to make salary reduction contributions.

What are 401(k) plans?

Your employer may establish a defined contribution plan that is a cash or deferred arrangement, usually called a 401(k) plan.  A participant can elect to defer receiving a portion of their salary which is instead contributed on their behalf, before taxes, to the 401(k) plan.  Sometimes the employer may match their contributions.  There are special rules governing the operation of a 401(k) plan.  For example, there is a dollar limit on the amount a participant may elect to defer each year.  The dollar limit in 2001 is $10,500 ($11,000 in 2002).  The amount may be adjusted annually by the Treasury Department to reflect changes in the cost of living.  Other limits may apply to the amount that may be contributed on a participant's behalf.  For example, if the participant is highly compensated, they may be limited depending on the extent to which rank and file employees participate in the plan.  An employer must advise participant's of any limits that may apply to them.

Although a 401(k) plan is a retirement plan, participants may be permitted access to funds in the plan before retirement.  For example, if a participant is an active employee, the plan may allow them to borrow from the plan.  Also, the plan may permit a withdrawal on account of hardship, generally from the funds the participant contributed.  The sponsor may want to encourage participation in the plan, but it cannot make participants' elective deferrals a condition for the receipt of other benefits, except for matching contributions.

The adoption of 401(k) plans by a state or local government or a tax-exempt organization is limited by law.

What are profit sharing plans or stock bonus plans?

A profit sharing or stock bonus plan is a defined contribution plan under which the plan may provide, or the employer may determine, annually, how much will be contributed to the plan (out of profits or otherwise).  The plan contains a formula for allocating to each participant a portion of each annual contribution.  A profit sharing plan or stock bonus plan may include a 401(k) plan.

What are employee stock ownership plans (ESOPs)?

Employee stock ownership plans (ESOPs) are a form of defined contribution plan in which the investments are primarily in employer stock.  Congress authorized the creation of ESOPs as one method of encouraging employee participation in corporate ownership.

When should participants expect to receive distributions from their 401k pension plans after terminating employment?

Generally, the law requires plans to pay retirement benefits no later than the time a participant  reaches normal retirement age.  But, many plans, including 401(k) plans, provide for earlier payments under certain circumstances.  For example, a plan's rules may provide that participants in a 401(k) plan would receive payment of his or her benefits after terminating employment.  The plan's SPD or Summary Plan Description should set forth the plan’s rules for obtaining the distribution as well as the timing of distribution after termination of employment.

How long does a participant have to wait to become a member of a 401k pension plan and to become vested in their benefits?

Generally, a plan may require a person to reach age 21 to be eligible to participate in the plan and to have a year of service.  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 own contributions.

Beginning in 2002, there are two basic vesting schedules.  Under the three-year schedule, workers are 100% vested after three years of service under the plan.  The six-year graduated schedule allows workers to become 20% vested after two years and to vest at a rate of 20% each year thereafter until they are 100% vested after six years of service.  Plans may have faster vesting schedules.

What protections do the fiduciary rules of ERISA provide?

ERISA protects plans from mismanagement and misuse of assets through its fiduciary provisions.  ERISA defines a fiduciary as anyone who exercises discretionary control or authority over plan management or plan assets, anyone with discretionary authority or responsibility for the administration of a plan, or anyone who provides investment advice to a plan for compensation or has any authority or responsibility to do so.  Plan fiduciaries include, for example, plan trustees, plan administrators, and members of a plan's investment committee.

The primary responsibility of fiduciaries is to run the plan solely in the interest of participants and beneficiaries and for the exclusive purpose of providing benefits and paying plan expenses.  Fiduciaries must act prudently and must diversify the plan's investments in order to minimize the risk of large losses.  In addition, they must follow the terms of plan documents to the extent that the plan terms are consistent with ERISA.  They also must avoid conflicts on behalf of the plan that benefit parties related to the plan, such as other fiduciaries, service providers, or the plan sponsor.

Fiduciaries who do not follow these principles of conduct may be personally liable to restore any losses to the plan, or to restore any profits made through improper use of plan assets.  Courts may take whatever action is appropriate against fiduciaries who breach their duties under ERISA including their removal.

When must employers deposit withheld employee contributions into a 401(k) plan or other pension plan?

Employers must transmit employee contributions to 401k pension plans as soon as they can reasonably be segregated from the employer’s general assets, but not later than the 15th  business day of the month immediately after the month in which the contributions either were withheld or received by the employer.

Can a 401k pension be attached for family support?

In general, 401k pension benefits cannot be taken away from a participant by people to whom they owe money.  The law makes a limited exception, however, when family support is at stake.  Thus, a state court can award part or all of a participant's 401k pension benefit to their spouse, former spouse, child or other dependent by issuing a qualified domestic relations order, which must be honored by the plan.  The person named in such an order is called an alternate payee.  The court's order can be in the form of a state court judgment, decree or order, or court approval of a property settlement agreement.

What requirements must be met for a domestic relations order to be qualified?

When a plan receives a domestic relations order purporting to divide 401k pension benefits, it must first determine whether the order is a qualified domestic relations order (QDRO).  The order must relate to child support, alimony, or marital property rights and be made under state domestic relations law.  To be qualified, the order should clearly specify your name and last known mailing address and the name and last address of each alternate payee.  It also must state the name of your plan; the amount or percentage - or the method of determining the amount or percentage - of the benefit to be paid to the alternate payee; and the number of payments or time period to which the order applies.  The order cannot provide a type or form of benefit not otherwise provided under the plan and cannot require the plan to provide an actuarially increased benefit.  And if an earlier QDRO applies to your benefit, the earlier QDRO takes precedence over a later one.

In certain situations, a QDRO may provide that payment is to be made to an alternate payee before the participant is entitled to receive their benefit.  For example, if the participant is still employed, a QDRO could require payment to an alternate payee to begin on or after their earliest retirement age, whether or not the plan would allow you to receive benefits at that time.

Can a plan be terminated?

Although 401k pension plans must be established with the intention of being continued indefinitely, employers may terminate plans.  If a plan terminates or becomes insolvent, ERISA provides participants some protection.  In a tax-qualified plan, a participant's accrued benefit must become 100 percent vested immediately upon plan termination, to the extent then funded.  If a partial termination occurs in such a plan, for example, if an employer closes a particular plant or division that results in the termination of employment of a substantial portion of plan participants, immediate 100 percent vesting, to the extent funded, also is required for affected employees.

What is the role of the U.S. Department of Labor in regulating pension plans?

The U.S. Department of Labor enforces Title I of ERISA, which, in part, establishes participants' rights and fiduciaries' duties.  However, certain plans are not covered by the protections of Title I.  They are:

Federal, state, or local government plans, including plans of certain international organizations.

Certain church or church association plans.

Plans maintained solely to comply with state workers' compensation, unemployment compensation or disability insurance laws.

Plans maintained outside the United States primarily for non-resident aliens.

Unfunded excess benefit plans - plans maintained solely to provide benefits or contributions in excess of those allowable for tax-qualified plans.

The U.S. Department of Labor's Employee Benefits Security Administration is the agency charged with enforcing the rules governing the conduct of plan managers, investment of plan assets, reporting and disclosure of plan information, enforcement of the fiduciary provisions of the law, and workers' benefit rights.  For more information, call EBSA's Toll-Free Employee & Employer Hotline number at: 1.866.444.EBSA (3272).

What other federal agencies regulate plans?

The Treasury Department's Internal Revenue Service is responsible for ensuring compliance with the Internal Revenue Code, which establishes the rules for operating a tax-qualified 401k pension plan, including pension plan funding and vesting requirements.  A pension plan that is tax-qualified can offer special tax benefits both to the employer sponsoring the plan and to the participants who receive pension benefits.  The IRS maintains a taxpayer assistance line for employee plans at 202.283.9516 (1:30-3:30 p.m. EST, Monday-Thursday).
The Pension Benefit Guaranty Corporation, PBGC, a non-profit, federally-created corporation, guarantees payment of certain pension benefits under defined benefit plans that are terminated with insufficient money to pay benefits.  The PBGC may be contacted at:

Pension Benefit Guaranty Corporation
1200 K Street NW
Washington, DC 20005-4026
Tel 202.326.4000
Toll free 800.400.7242

Understanding Pension Law

General Introduction

The office of Employee Plans (EP) under the Tax Exempt & Government Entities (TE/GE) operating division of the Internal Revenue Service helps retirement plan sponsors, plan participants, and practitioners working in the retirement benefits arena understand and comply with the pension law.

Historical Background

On September 2, 1974, President Ford signed into law the Employee Retirement Income Security Act of 1974, Public Law 93-406, 93d Cong. 1st Sess. (1974), 1974-3 C.B. 1, (ERISA). The Act completely revised the legal framework of the qualified pension plan as it had previously existed. The most significant innovations of ERISA concerned minimum participation and vesting standards and the manner in which benefits were paid with some protection extending to the surviving spouse of the plan participants.  In addition, the Act imposed upon all pension plans certain minimum funding requirements.

Administrative Responsibility for Retirement Plans

Under ERISA, jurisdiction over employee benefit plans was divided among the Internal Revenue Service (IRS), the Department of Labor (DOL) and the Pension Benefit Guaranty Corporation (PBGC).

The responsibility of the IRS centers on plans covered by Internal Revenue Code (IRC) section 401(a), and includes pension, profit-sharing, and stock-bonus plans.  The DOL shares some responsibility in this area, but primarily from the perspective of fiduciary responsibility and prohibited transactions.  DOL is also responsible for such plans as health and welfare plans, legal aid plans and other plans that are not designed to provide retirement benefits or the deferral of income.

The PBGC is a government corporation created by ERISA that functions as insurer of a minimum guaranteed benefit for certain pension plans.  Although jurisdiction is divided among the agencies, the Act requires that they coordinate their activities.  This activity most commonly occurs between the IRS and DOL due to the overlap in the nature of their responsibilities.

What We Do

The pension law provides significant tax benefits for sponsors of certain retirement plans (such as 401(k) plans) and the employees that participate in them. Our EP Examinations activities promote voluntary compliance by analyzing operational features of retirement plans. A centralized examination case selection and review process is used to enhance consistency of enforcement activities and to focus resources on the areas of highest noncompliance. Through our Customer Education & Outreach office, we provide services and information about retirement plan requirements.  Our services under Rulings and Agreements are designed to help customers understand and comply with the pension law, and assist customers in correcting mistakes that may occur when administering the plan.  These services help conserve plan benefits until an employee’s retirement, and help preserve the tax benefits associated with these plans.  Additional information regarding our unique services is presented in our online brochure, Publication 3636. rrp