Overview of the Employee Retirement Income Security Act - Module 1 of 5

Module 1-Overview of the Employee Retirement Income Security Act

A pension plan is a type of retirement plan that requires an employee to make regular contributions while her employer may match or also contribute.[1] The federal government incentivizes private employers to provide these plans by offering tax deductions for employer contributions to qualified plans.[2] Moreover, an employee can avoid paying taxes on deferred compensation until the plan benefits are paid out.

The Employee Retirement Income Security Act of 1974, which we will refer to as ERISA, “is a federal law that sets minimum standards for most voluntarily-established pension and health plans.”[3] It “was enacted because existing state and federal laws didn’t adequately protect employee benefit plan participants and beneficiaries.”[4] ERISA requires increased disclosure and reporting to plan participants, mandates that those who are entrusted with retirement assets follow a certain level of care and creates remedies for participants whose protections are violated.[5]

            In our first module, we’ll examine ERISA’s basic principles. We’ll explain the purpose behind the law, what ERISA covers and ERISA-mandated responsibilities for plan administrators and sponsors.

ERISA’s History and Purpose

American Express established the first corporate pension in the United States in 1875, and banking and rail companies followed suit.[6] Early pensions were viewed as an employer’s gift to employees for their service rather than legally protected compensation.[7] Many times, pensions didn’t vest, so when an employee changed or lost his job, they would lose their entire pensions.[8]

Private-sector pension plans gained popularity after World War II, and labor unions started demanding such plans alongside demands for higher wages. However, the companies that established those plans didn’t always properly fund them and many employees were left without promised benefits when those companies failed or filed for bankruptcy.[9]

With this rise of private pension plans, the federal government became more active in its oversight. Congress passed the Welfare and Pension Plans Disclosure Act in 1958. Though the Act was limited in scope, it required covered employers to file plan descriptions and annual financial reports with the federal government and to make such documents available to plan participants and beneficiaries.[10]

Public scrutiny of employer plan management reached a high point in 1963 when automotive manufacturer Studebaker Corporation shut down. The company’s pension plan was so underfunded that more than 4,000 workers at its South Bend, Indiana, plant lost much of their promised benefits.[11] After that, the United Auto Workers union, representing workers at Studebaker, started lobbying for federal pension insurance and increased regulation.[12]

On Capitol Hill, Senator Jacob K. Javits became the leading voice for pension reform. Considered the “grandfather of ERISA,”[13] Javits was ERISA’s main author.[14] In 1967, Javits introduced the first comprehensive private pension reform bill. Over the next decade, congressional emphasis on the need for comprehensive pension plan reform grew. ERISA was signed into law in 1974 and since then, ERISA has been amended several times to meet “the changing needs of America’s workers and their families.”[15]

ERISA does not require an employer to provide any employee benefits. Likewise, it doesn’t require that a plan provide a minimum level of benefits, so an employer is free to design its own plan or to not offer one at all.[16] However, once an employer does decide to provide benefits that are subject to ERISA, the law regulates the plan’s operation and benefits.

ERISA’s essential objective is to protect employee pension rights from mismanagement and abuse. It achieves this objective by:

·         requiring plan sponsors to provide certain information to participants;

·         establishing standards of conduct for plan managers and other fiduciaries;

·         establishing enforcement provisions that are designed to protect plan funds and ensure that participants receive their benefits; and

·         giving participants the right to sue for benefits and fiduciary violations.

ERISA requires a plan sponsor and administrator, typically the employer, to act in the best interest of plan participants and requires the plan administrator to allow participants to access important information about their plans. By allowing access to this information, participants can understand the benefits to which they are entitled. Furthermore, an employer must ensure that service providers for pension plans charge only “reasonable” fees for recordkeeping, investment management and other plan maintenance activities. Finally, a plan’s sponsors must follow and consistently apply the terms described in the documents that govern the plan.

ERISA Terminology

We’ll begin with plan terminology. A participant is an employee who contributes to and/or is eligible to receive benefits from an employer-sponsored plan. A beneficiary is a person designated by the participant or the plan who is or may become eligible to receive benefits. A plan sponsor is the employer, labor union or other professional organization that sets up the benefit plan. A plan administrator is generally responsible for the day-to-day management of the plan and ensuring that it complies with ERISA regulations.

A plan sponsor must provide participants with a written plan document, called a Summary Plan Description. This document provides detailed information about the plan’s features and describes benefits, rights and obligations in plain language.[17] Certain events and dates trigger the obligation to provide participants with copies of the summary plan description. A trustee holds the investment assets in a trust for employees. An investment manager has the power to manage, acquire or dispose of plan assets.

Retirement Benefits Plans

ERISA covers two types of retirement plans: defined benefit plans and defined contribution plans.[18] A defined benefit plan was traditionally referred to as a “pension.”[19] Typically, an employer funds the plan and invests contributions on the employee’s behalf. The employee must work for the employer for a set time, such as five years, to be fully “vested” in the plan.[20] When the employee retires, she’ll receive a set monthly amount so long as she satisfies eligibility requirements. The amount the employee receives during retirement may be a specific dollar amount or an amount based on a formula that factors in the employee’s salary and duration of service,[21] with the latter being more common.

In a defined contribution plan, the employer or the employee, or both, make fixed contributions to the employee’s retirement fund. For example, an employee might contribute six percent of his salary to a defined contribution plan each pay period and the employer may contribute an additional three percent to the employee’s account. Common defined contribution plans include 401(k), employee stock ownership and profit-sharing plans.[22] These plans may be less risky for an employer than defined benefit plans for a variety of reasons, particularly because the employee bears the investment risks.[23] Employees may also like these plans because employees have control over the investments and can generally take their plans from one employer to the next.[24]

Welfare Plans

ERISA also covers welfare benefits, which include almost all the other typical employment benefits, such as health insurance, life insurance, long-term disability insurance and accident benefits plans.”[25]

People who manage welfare plans must meet certain standards of conduct. As with retirement plans, welfare plan fiduciaries must run the plan in the best interests of participants and beneficiaries. Plans must be run for the exclusive purpose of providing benefits and paying plan expenses. 

It is important to note that there are some exemptions and safe harbors that carve out welfare plans that might otherwise be subject to ERISA.[26] For example, under the “payroll practice” exemption, certain health and welfare payments are exempt from ERISA if they are made as part of the employer’s normal payroll practices. Wages, vacation and holiday pay and paid sick leave are examples of benefits that may qualify under this exemption. Additionally, some programs that allow employees to make payments via payroll deductions for voluntary insurance policies may fall outside of ERISA’s purview.

Multiemployer Plans

Multiemployer plans are established through collective bargaining agreements with labor unions and cover workers at multiple companies, typically within one industry. Participating employees are usually members of the same craft or trade and may work in industries comprised of many small employers or in industries where seasonal, mobile or irregular work is common.[27] A multiemployer plan can be a retirement or a welfare plan.

ERISA’s Structure and Application

Although ERISA covers nearly all plans offered by private employers, including corporations, partnerships, sole proprietorships, and nonprofit organizations, it does not apply to plans sponsored by state or federal government or established and maintained by churches or other religious establishments for their employees. These plans are instead subject to regulation under the Internal Revenue Code, which provides requirements that allow them to keep tax-exempt status. State pension plans are primarily governed by state constitutions, statutes and case law.[28]

ERISA also doesn’t apply to plans that are maintained only to comply with state laws, such as unemployment compensation, workers’ compensation and disability insurance.[29] Finally, ERISA doesn’t apply to plans that are maintained outside of the United States for nonresident aliens.

ERISA is a broad and complex law that is divided into four titles and has shared oversight among three federal agencies: The Department of Labor, the Internal Revenue Service and the Pension Benefit Guaranty Corporation.[30]

ERISA’s Title I spells out reporting and disclosure, vesting, participation, funding, fiduciary conduct and civil enforcement.[31] The Department of Labor’s Employee Benefits Security Administration is responsible for administering this part. It is responsible for enforcement and provides compliance assistance and assists and educates plan participants and beneficiaries.[32]

Title II amended the Internal Revenue Code to parallel many of the Title I rules and is administered by the IRS. Title III covers jurisdictional matters and addresses coordination of enforcement and regulatory activities by the Department of Labor and the IRS. Title IV covers insurance for defined benefit pension plans and is administered by the Pension Benefit Guaranty Corporation.[33] The Pension Benefit Guaranty Corporation is a federal agency that insures participant benefits, guaranteeing basic benefits if an employer-sponsored plan becomes insolvent.

Preemption

“ERISA supersedes state laws relating to employee benefit plans except for certain matters such as state insurance, banking and securities laws and divorce property settlement orders by state courts.”[34] This means that a state cannot pass laws that interfere with ERISA and that federal law will supersede state law when there is a conflict between the two.[35]

However, ERISA provides that it does not “exempt or relieve any person from any law of any State which regulates insurance, banking, or securities.” This “savings clause” is important because states have historically regulated the insurance industry. ERISA’s “deemer clause,” though, clarifies that no employee benefit plan shall be deemed to be an insurance company, bank, trust company or investment company for the purpose of state regulation.[36] As such, it preserved the primacy of ERISA in dealing with employee benefit plans.

Though detailed, ERISA’s broad preemption clause is a source of confusion and its scope has been heavily litigated throughout the years.[37] For example, the Supreme Court ruled in 2017 that pension plans established and maintained by religiously affiliated nonprofit organizations—like those offered by certain hospitals and schools—can qualify as exempt church plans.[38] This issue had been the source of several class-action lawsuits in recent years.[39]

Duties under ERISA

Since ERISA establishes transparency and accountability for employee benefit plans,[40] a key element of compliance for plan sponsors and administrators is to follow detailed notice and disclosure procedures. For example, participants must have access to information about their plans and any associated fees or changes in benefits. There are many reporting and disclosure requirements, but the following is a brief summary of two critical documents.

Form 5500

ERISA-governed retirement and welfare plan sponsors must each file a Form 5500 with the federal government annually. This is a public document that plan participants can review to learn about the plan’s compliance and performance and that government agencies can use to collect and study data. The data collected in this way can be used by federal agencies to craft policy and enforcement decisions.[41]

Notification of Benefit Determination

Plan participants must receive notification when a benefit claim has been approved or denied. A notice of claim denial must state the reasons for the denial and provide information about the appeals procedure.

Fiduciary Duties

ERISA sets fiduciary standards that require employee benefit plan funds to be handled prudently and in the best interests of the participants. A person associated with a plan is a “fiduciary” if he exercises any discretionary authority or control over the management of the plan or disposition of plan assets, renders investment advice for a fee or other compensation with respect to any plan asset or has any discretionary responsibility in the administration of the plan.[42] Trustees, administrators and members of a plan's investment committee are examples of those with fiduciary duties.

Compliance with ERISA’s many requirements can be daunting for a fiduciary, but failure to comply can result in significant penalties.[43] In addition to hefty monetary fines, fiduciaries may face criminal charges for serious offenses, such as embezzlement or accepting kickbacks.[44] Thus, it is critical for fiduciaries to understand their obligations and to carefully follow their reporting and disclosure requirements and their fiduciary duties.

            There are four duties that a fiduciary owes to plan participants and beneficiaries. The first is a duty of loyalty, which requires a fiduciary to discharge his duties “solely in the interest of the participants and beneficiaries” and for the “exclusive purpose” of providing benefits to participants and beneficiaries.[45] Second is a duty of prudence, which means that a fiduciary must make any decision impacting a plan with the care, skill, prudence and diligence that a sensible person would use under the circumstances. Third, there is a duty to diversity investments of plan assets “so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so.”[46] Finally, a fiduciary has a duty to act in accordance with plan documents, which means that he must comply with the terms of writings that have a substantive effect on a plan, including collecting and preserving bargaining agreements and memoranda regarding the sale of plan assets.[47]

            In our second module, we’ll analyze the treatment of qualified retirement plans under ERISA and we’ll learn more about the types of retirement plans that ERISA covers.