What Is Public Law 93-406 (ERISA)?

Public Law 93-406, the Employee Retirement Income Security Act of 1974 (ERISA), is a federal law that sets minimum standards for most voluntarily established retirement and health plans in the private sector. Its passage was a response to corporate pension plan failures that left long-serving employees with little to no retirement benefits. A notable incident involved the Studebaker automobile company, where plan termination left some workers with only a fraction of their earned benefits.

ERISA protects the interests of plan participants and their beneficiaries by regulating how these benefit plans operate. The law does not require an employer to establish a plan or set a specific benefit amount. Instead, it creates rules for established plans, covering participation, funding, disclosure, and fiduciary conduct. The Department of Labor, the Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corporation share responsibility for administering and enforcing the law.

Key Participant Protections

ERISA sets minimum standards for when an employee must be allowed to join a plan. A plan must permit an employee to participate after they reach age 21 and complete one year of service. This provision prevents employers from using excessively long waiting periods to exclude workers from accumulating benefits.

An employee’s right to accumulated benefits is protected by vesting and benefit accrual rules. Vesting is the process of earning a non-forfeitable right to employer-provided benefits. While an employee’s own contributions to a plan are always 100% immediately vested, the rights to employer contributions are earned over time according to a schedule.

For defined contribution plans, there are two primary vesting schedules. The first is a three-year “cliff” vesting schedule, where an employee becomes 100% vested after three years of service but is 0% vested before that point. The alternative is a two-to-six-year “graded” schedule, where vesting increases by 20% each year starting in the second year, reaching 100% after six years.

For defined benefit pension plans, the schedules are slightly different, allowing for a five-year cliff vesting schedule or a three-to-seven-year graded schedule. Benefit accrual rules also prevent employers from reducing benefits that a participant has already earned, ensuring the value of a promised pension does not decrease retroactively.

ERISA also incorporates specific protections for the spouses of plan participants. For defined benefit pension plans and certain other retirement plans, the law mandates the offering of survivor benefits. A Qualified Joint and Survivor Annuity (QJSA) must be the default form of benefit payment for a married participant, providing income for the participant’s life and a continuing payment to the surviving spouse after death.

If a vested participant dies before retirement age, the plan must provide a Qualified Preretirement Survivor Annuity (QPSA) to the surviving spouse. This ensures the spouse receives a benefit even if the participant passes away before payments have begun. A participant can choose a different form of payment, but only with the written, notarized consent of their spouse.

Fiduciary Responsibilities

ERISA imposes strict standards of conduct on individuals and entities, known as fiduciaries, who manage and control employee benefit plans. Anyone who exercises discretionary authority over plan management or assets is considered a fiduciary, including plan trustees, administrators, and members of an investment committee. Fiduciaries must manage the plan with the sole interest of participants and their beneficiaries in mind.

The law establishes several core obligations for fiduciaries:

• The duty of loyalty requires fiduciaries to act exclusively for the benefit of participants. This means all decisions must be made with the goal of providing benefits and defraying reasonable plan expenses. Fiduciaries are prohibited from engaging in transactions that involve a conflict of interest, and a breach can result in personal liability for any losses incurred by the plan.
• The duty of prudence, often called the “prudent person” rule, requires a fiduciary to act with the care, skill, and diligence that a knowledgeable person would use in a similar situation. It is not enough to act in good faith; the fiduciary must demonstrate a sound process for making decisions. This includes evaluating investment options, monitoring their performance, and ensuring that fees are reasonable.
• ERISA mandates a duty to diversify the plan’s investments to minimize the risk of large losses. Concentrating a plan’s assets in a single stock or a single sector of the economy would generally be a violation of this duty. By spreading investments across various asset classes, fiduciaries can help protect the plan from significant downturns in any one area.
• Fiduciaries have a duty to follow the plan’s governing documents, which outline the rules for eligibility and benefits. They must adhere to these terms, but only to the extent that the documents are consistent with ERISA’s legal requirements. If a provision in a plan document conflicts with the law, the fiduciary is obligated to follow the law.

Required Reporting and Disclosures

ERISA ensures that plan participants have access to clear and timely information about their benefits. The law mandates a system of reporting and disclosure to provide transparency into how plans are managed and funded. This allows participants to understand their rights and monitor the financial health of their benefit plans.

Plan administrators must provide a Summary Plan Description (SPD) to new participants within 90 days of their becoming covered by the plan. The SPD must be written in plain language that is easy for the average participant to understand. It serves as a guide to the plan, detailing eligibility requirements, benefit calculations, vesting rules, claim procedures, and a statement of the participant’s rights under ERISA.

Participants must also receive a Summary Annual Report (SAR) each year. The SAR is a concise summary of the plan’s annual financial report, the Form 5500, which is filed with the Department of Labor. It provides a snapshot of the plan’s financial activities, including assets, liabilities, income, and expenses. The SAR must be distributed within nine months of the end of the plan year.

Participants are also entitled to receive an Individual Benefit Statement. This statement provides a personalized look at a participant’s own benefits, detailing the total benefits earned and the value of vested benefits. For defined contribution plans like 401(k)s, these statements are provided at least quarterly. For defined benefit pension plans, they may be provided annually or upon request.

The main government report is the Form 5500 Annual Return/Report of Employee Benefit Plan. Plans with 100 or more participants must file this detailed report electronically with the Department of Labor each year. The Form 5500 contains extensive, publicly available information about the plan’s finances, investments, and operations.

Plan Funding and Insurance

ERISA establishes minimum funding standards for defined benefit pension plans. These rules are designed to ensure that employers contribute enough money each year to cover the retirement benefits their employees are earning. The law requires these plans to calculate their liabilities and maintain sufficient assets to meet those obligations. This prevents a company from promising a pension but failing to set aside the necessary funds.

These funding requirements do not apply to defined contribution plans, such as 401(k)s. In those plans, the employee’s benefit is based on the balance in their individual account, which consists of contributions and investment returns. The employer’s obligation is limited to making the specified contributions, not guaranteeing a specific benefit amount at retirement.

To provide security for traditional pensions, Title IV of ERISA created the Pension Benefit Guaranty Corporation (PBGC). The PBGC is a federal agency that acts as an insurance program for private-sector defined benefit plans. If a company with a covered pension plan fails and the plan is terminated without enough money to pay all promised benefits, the PBGC takes over as the plan’s trustee. The agency then pays benefits to retirees and their beneficiaries, up to a legal maximum limit that is adjusted annually.

This insurance program is funded by premiums paid by the sponsors of covered plans, assets from terminated plans it takes over, and investment income. The PBGC’s guarantee insures private defined benefit pension plans. It does not cover defined contribution plans like 401(k)s, 403(b)s, or Individual Retirement Accounts (IRAs).