What Is the Anti-Cutback Rule for Retirement Plans?
Understand the federal provision that defines the line between an employee's earned retirement benefits and an employer's ability to modify plan terms.
The anti-cutback rule is a provision found in federal laws such as the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code (IRC). The rule’s purpose is to prevent employers from making retroactive changes to their retirement plans that would decrease the benefits an employee has already earned. The anti-cutback rule applies to various actions an employer might take, including formal plan amendments, mergers with other plans, or other changes that could affect the accrued benefits of plan participants.
Protected Accrued Benefits
The anti-cutback rule provides a shield for what is known as a participant’s “accrued benefit.” This term refers to the amount of retirement benefit an employee has earned as of a specific date. The nature of this benefit differs depending on the type of retirement plan. For individuals in a defined benefit plan, often called a pension plan, the accrued benefit is expressed as an annual or monthly payment the participant is entitled to receive upon reaching the plan’s normal retirement age.
In a defined contribution plan, such as a 401(k) or a profit-sharing plan, the accrued benefit is defined as the balance in the participant’s individual account. This balance consists of employee contributions, employer contributions, and any investment gains or losses. For example, if a plan sponsor amends the vesting schedule to be less favorable, the new schedule cannot reduce the vested percentage of a participant’s existing accrued benefit.
Beyond the core retirement payout, the rule also protects early retirement benefits and any associated subsidies. Many pension plans allow employees to retire before the normal retirement age and offer a subsidy, meaning the monthly benefit is not reduced as much as it would be under standard actuarial calculations. If a participant has met the requirements for such a subsidized early retirement option, an employer cannot amend the plan to eliminate or reduce that subsidy for the benefits already earned.
The rule also extends its protection to optional forms of benefit payments available under a plan. Retirement plans frequently offer participants choices in how they receive their money, such as a single lump-sum payment versus a series of lifetime monthly payments known as an annuity. If a plan has historically offered a lump-sum option, an employer cannot amend the plan to remove that option with respect to the benefits a participant has already accrued.
Permissible Reductions and Plan Changes
While the anti-cutback rule is robust, it does not prevent employers from making all changes to a retirement plan. A distinction exists between reducing benefits already earned and altering the rate at which future benefits are earned. An employer is permitted to amend a plan to reduce the rate at which employees will earn benefits from that point forward, as the rule does not protect the formula for future benefit accruals.
This principle allows for what is commonly known as a “plan freeze.” An employer can decide to freeze a defined benefit plan, which means that participants will no longer earn any additional benefits under the plan’s formula for their future service. The benefits that employees have already earned up to the date of the freeze are protected and must be preserved.
The protections of the anti-cutback rule are aimed at retirement-type benefits and do not extend to ancillary or welfare benefits. Examples of these non-protected benefits include life insurance coverage, disability benefits, or medical insurance offered to retirees. An employer can modify or eliminate these types of benefits without violating the anti-cutback rule.
Employers also retain the flexibility to change administrative aspects of a retirement plan. For instance, in a 401(k) plan, the employer or plan sponsor can change the lineup of investment funds available to participants. These investment options are not considered a protected accrued benefit.
Exceptions to the Rule
There are specific and legally defined circumstances where benefits that are normally protected by the anti-cutback rule can be reduced. When two company retirement plans are merged, often following a corporate acquisition, minor modifications to benefit options may be allowed. Treasury regulations provide a framework that permits the elimination of certain optional forms of benefit during a merger to streamline plan administration, so long as core options like lump-sum distributions or annuities are preserved.
An employer may also be permitted to amend a plan to correct a clear and demonstrable error in the plan document, often referred to as a “scrivener’s error.” If the written plan document contains a mistake that does not reflect the original, intended plan design, a retroactive amendment may be allowed. An example is a typo that results in a much higher benefit calculation than was ever intended.
Federal law also provides for exceptions in cases of significant financial distress. Under the Multiemployer Pension Reform Act of 2014, certain multiemployer pension plans facing insolvency may be permitted to reduce some benefits. If a plan is certified by its actuary as being in “critical and declining” status, the plan sponsor can apply to the Treasury Department for approval to suspend benefits that would otherwise be protected.