Employee Retirement Income Security Act (ERISA)

What is “Employee Retirement Income Security Act”

The term Employee Retirement Income Security Act (ERISA), enacted in 1974, is a federal law in the U.S. that seeks to provide protection to individuals vis-à-vis most voluntarily established privately-sponsored pension and health plans offered by the private sector. ERISA, which is enforced by the Employee Benefits Security Administration (EBSA), a unit of the Department of Labor (DOL), sets the minimum standards for most of these voluntarily plans. Under the law, it is incumbent upon these plans to regularly inform participants about the features of the same and funding.

Under ERISA, certain laws have been formulated and implemented to prevent plan fiduciaries from misusing plan assets. Basically, this act has established certain standards of conduct, responsibilities, and obligations for the fiduciaries of these plans, in order to protect the interest of those employees and their beneficiaries who participate in the same. Further, this act empowers participants with easy access to federal courts, in case of disputes between the participants and plan providers, and it also provides suitable remedies and sanctions. ERISA was enacted because existing state and federal laws at that time did not provide adequate protection to employee benefit plan participants and beneficiaries.

ERISA Terminology

There are certain terminologies used vis-à-vis ERISA that one should be aware of. The same are stated below.

Participant: you have employer-sponsored pension and health plans offered by organizations in the private sector i.e. privately sponsored plans, to which employees contribute to and/or are eligible to receive benefits from the same. Such employees are known as participants.

Beneficiary: if a person receives benefits from say a group health plan, such as Medicaid, or Original Medicare, then the person is known as a beneficiary of that health plan. Another example is of a pension plan, which offers a secure lifetime source of income after retirement. In the eventuality of the death of the pensioner, the pension may provide financial care to other entities who can be family members, friends, charities, etc. who are important to the pensioner. These entities are known as beneficiaries.

Plan sponsor: the professional organization, employer, or labor union that sets up the benefit plan is termed as the plan sponsor. The plan sponsor provides the participants with detailed information about the features of the plan and its benefits, rights, and obligations in jargon-free language.

Investment manager: is the person who is responsible to manage, acquire or sell off the assets of the plan and is vested with the power to do so.

Trustee: a trustee holds the investment assets of a plan in a trust for employees.

Plan administrator: is responsible to ensure that all the compliances relating to the plan are met vis-à-vis ERISA’s regulations and is responsible for the day-to-day management of the plan.

Fiduciary: a fiduciary includes trustees, plan administrators of a plan, and investment committees who possess discretionary authority or control over certain employer-sponsored retirement or healthcare plans. A fiduciary is also anyone who gives advice related to investments on the direction of these assets.

Types of Plans Covered Under ERISA

Retirement Benefit Plans: there are two types of retirement plans covered by ERISA. These are defined benefit plans and defined contribution plans. The former is a particular type of pension plan where a sponsor/employer promises to contribute a specified pension payment, lump sum, or a combination on the employee’s behalf upon his or her retirement. The amount contributed by the employer depends on various factors such as the employee’s salary record, age, and length of service. Typically, in such plans, the employer funds the plan, and the contributions are invested on the employee’s behalf. To be fully vested in the plan, the employee has to work for a set period of time or number of years for the employer. The employee upon retirement receives a set amount of money every month, as long as he or she fulfills the eligibility requirements.

Defined Contribution Plans: this is a type of retirement plan, which is common, where an employee contributes money to the plan and typically, the employer makes a matching contribution i.e. both make fixed contributions to the employee’s retirement fund. For example, an employee might contribute a certain specified percentage of his or her earnings to a defined contribution plan in each period where he or she receives pay and the employer may contribute an additional percent to the employee’s account.

The two types of plans which are popular are 401(k) and 403(k). In the U.S., these are the two most widely used types of employer-sponsored benefit plans. Further, unlike the former type of plan, in defined contribution plans, both the employee and the employer can contribute to the employee’s individual account. Whereas, in a defined benefit plan, generally only the employer contributes and the employee gets a fixed amount of monthly payment after he or she retires. Given that the employee bears the investment risks, defined contribution plans pose less risk for an employer than defined benefit plans.

Welfare Plans: ERISA also covers welfare plans. A welfare plan is any plan, program, or fund that is maintained by an employer to provide the employee with medical or hospital care, unemployment benefits, retirement plans, holiday or severance pay, apprenticeship and training programs, and some other benefits. Welfare fund fiduciaries must ensure that they operate the plan keeping in mind the best interests of participants and beneficiaries.

Multiemployer plans (MEP): this is a retirement savings plan, which is adopted by two or more employers, typically within one industry. For income tax purposes, the two employers are not related. These types of plans can be either defined benefit pension plans or defined retirement plans. MEP’s are established through collective bargaining agreements with labor unions and cover workers at multiple companies, typically within one industry. A multi-employer plan can be retirement or a welfare plan. The sponsor of an MEP organizes and runs such types of plans. Such plans were created to incentivize small-sized firms to offer their employees a retirement saving plan with tax advantages.

ERISA – Types of Protection

Over the years, with the rise in private pension plans in the US, the oversight of the same has become more stringent. The underlying objective of ERISA is to safeguard the pension rights of employees from or against mismanagement and any sort of violation or abuse. This act achieves this objective by offering certain kinds of protections (stated below).

Under ERISA, employees, who are participants in such plans, are provided with varied forms of protection – mostly related to health and retirement plans. By establishing the minimum standards for most voluntarily established retirement and health plans offered by private-sector employers, it seeks to provide protection to the participants of these plans. The enforcement of these protections is the responsibility of the Employee Benefits Security Administration (EBSA.) EBSA is part of the Department of Labor (DOL.)

ERISA offers the following protections to the employees who are participants in the plans:

Information: it is mandatory for the private company (sponsor) offering retirement and health plans to provide to the employees (participants in these plans) the features of the plan and  information related to funding. Further, ERISA has set certain standards vis-à-vis how firms can regulate the participation of their employees in these plans. This includes clearly defining the duration or number of years a company can require its employees to work for it, prior to being a participant in such plans. Further, ERISA also details whether or not the spouse of the employee who participates in such plans has the right to receive a part of the pension if he or she were to expire.

Fiduciaries: ERISA requires that those who are involved in the control of managing a plan’s assets must be its fiduciaries for those employees who are participants in the plan. It is incumbent upon the fiduciaries to always legally act in a way that keeps the best interests of the investors in mind. If fiduciaries don’t, then they can be held financially responsible for making up for any losses that a plan might incur. Under ERISA, standards of conduct have been established for fiduciaries and plan managers.

Termination of plan: ERISA provides protection to participants vis-à-vis the benefits offered by a plan, in the eventuality of the same being terminated. The enforcement provisions that have been established are designed to protect plan funds and to make sure that participants in such funds receive their benefits.

Breach of fiduciary duties: if there is any violation or breach of fiduciary duties, the participants of the plans have the right to take them to court for benefits and fiduciary violations, and get their benefits under ERISA.

Defined Contribution Mathematics – Example

In defined contribution plan in the U.S. – 401(K) – many employers provide a matching contribution to the employee’s 401(K) account. Such contributions can range from 0% to 100% of the employee’s contributions. Further, most employers allow employees to contribute up to 10% of their earnings (i.e. salary and not income from other sources) to a 401(K).

In the example below, we assume that the employer matches 50% of the employee’s contribution i.e. maximum contribution of 6% of an employee’s annual salary towards the plan. Further, we assume that the employee earns US$ 250,000 per year and he or she contributes 10% of his or her salary to the fund. The computations are stated below.

From the table above, we can gather that the total contributions (employer + employee contributions) amount to US$ 40,000.