Employer-Sponsored Qualified Plans and ERISA
Quick Answer
ERISA (Employee Retirement Income Security Act of 1974) sets minimum standards for most private-sector employer-sponsored retirement plans. It covers 401(k), 403(b), pension, profit-sharing, and ESOP plans with rules on eligibility (age 21, one year of service), vesting schedules, fiduciary duties, and funding. Governmental 457(b) plans and most church plans are exempt from ERISA.
IRAs are individual accounts. When an employer sponsors a retirement plan for employees, a federal law called ERISA (Employee Retirement Income Security Act of 1974) sets the minimum standards that govern eligibility, vesting, fiduciary duty, and funding.
Which retirement plans does ERISA cover?
ERISA sets minimum standards for most private-sector employee benefit plans. Covered plans include:
- 401(k) plans (corporate)
- 403(b) plans: tax-sheltered annuities (TSAs) for public schools, 501(c)(3) non-profits, and church plans
- Defined benefit (traditional pension) plans
- Defined contribution plans (401(k), profit-sharing, money purchase)
- Profit-sharing plans
- Employee Stock Ownership Plans (ESOPs) and stock bonus plans
ERISA does NOT cover:
- Governmental plans (including most 457(b)s)
- Church plans unless they elect in
- A governmental 457(b) is specifically a non-ERISA plan
What are the ERISA eligibility and vesting rules?
Eligibility: Most employees must be allowed to participate once they reach:
- Age 21 AND
- 1 year of service (1,000 hours or more in a 12-month period)
Vesting of employer contributions in defined contribution plans must use one of:
- 3-year cliff vesting: 100% vested after 3 years of service; nothing before
- 2-to-6-year graded vesting: 20% per year from years 2 through 6, reaching 100% at year 6
Employee elective deferrals (such as 401(k) salary deferrals) are immediately 100% vested at all times.
Exam Tip: Gotchas
- Employee elective deferrals to a 401(k) are always 100% vested immediately. Only employer contributions are subject to the 3-year cliff or 2-to-6-year graded vesting schedules under ERISA.
What fiduciary duties does ERISA impose on plan fiduciaries?
A fiduciary is anyone exercising discretionary authority or control over plan management, assets, or investment advice. Fiduciary duties include:
- Duty of loyalty: act solely in the interest of participants and beneficiaries
- Exclusive purpose: administer the plan for providing benefits and paying reasonable expenses only
- Prudent expert standard: act with care, skill, prudence, and diligence a knowledgeable person would use in similar circumstances
- Diversification: diversify plan investments to minimize risk of large losses
- Plan-document compliance: follow the terms of the written plan document
What are the 2025 401(k) elective deferral limits?
| Participant Age | 2025 Limit |
|---|---|
| Under 50 | $23,500 |
| 50-59 or 64+ (standard catch-up) | $23,500 + $7,500 = $31,000 |
| 60-63 (enhanced catch-up under SECURE 2.0) | $23,500 + $11,250 = $34,750 |
Additional limit rules:
- These limits apply to aggregate employee deferrals across 401(k)/403(b)/Salary Reduction SEP (SARSEP); the 457(b) has its own separate limit
- Employer match contributions are in addition to the employee limit, up to the overall defined-contribution plan limit of $70,000 in 2025
Think of it this way: The age-60-63 super catch-up is a narrow window. Workers get an extra boost right before retirement, then return to the regular 50+ catch-up at age 64. It is a use-it-or-lose-it opportunity.
How do 403(b) and 457(b) retirement plans differ?
| Feature | 403(b) | 457(b) |
|---|---|---|
| Who sponsors | Public schools, 501(c)(3) non-profits, churches | State and local governments, certain tax-exempt orgs |
| ERISA status | Generally ERISA-covered (except governmental/church plans) | Governmental 457(b) is NOT ERISA-covered; non-governmental 457(b) is a top-hat plan |
| Early withdrawal 10% penalty | Yes, before age 59-1/2 (standard IRS rule) | No 10% penalty on 457(b) distributions upon separation from service, regardless of age |
| Assets | Held in trust for employees | Governmental: held in trust; non-governmental must remain unfunded (assets of employer, subject to creditors) |
| Catch-up | 50+ catch-up; plus 15-year service catch-up (up to $3,000/year, $15,000 lifetime) | 50+ catch-up; special 3-year pre-retirement catch-up (up to 2x normal limit) |
Additional features:
- 457(b) non-governmental plans are top-hat plans available only to a select group of management or highly compensated employees
- 403(b) plans originally permitted only annuity contracts and mutual funds; still commonly invested in variable annuities and mutual-fund custodial accounts
Exam Tip: Gotchas
- Governmental 457(b) plans are NOT subject to ERISA and have no 10% early-withdrawal penalty upon separation from service. The exam tests this directly: if the question asks whether a 59-year-old city employee separating from service can tap a 457(b) penalty-free, the answer is yes.
What is the difference between defined benefit and defined contribution plans?
| Plan Type | Benefit Promised | Investment Risk |
|---|---|---|
| Defined benefit (pension) | A specified monthly benefit at retirement (often based on salary, age, years of service) | Employer bears investment risk (must fund the promised benefit) |
| Defined contribution | Account balance at retirement (contributions plus or minus investment returns); no fixed benefit | Employee bears investment risk |
How do profit-sharing plans, stock options, and stock purchase plans work?
- Profit-sharing plans: Employer decides each year how much (if any) to contribute; contributions may be cash or employer stock; allocation formula must be definite
- Stock options: Employer grants employees the right to buy company stock at a specified price; include Incentive Stock Options (ISOs) (favored tax treatment if holding-period rules met) and Non-Qualified Stock Options (NSOs or NQSOs) (ordinary-income tax at exercise on the spread)
- Employee Stock Purchase Plans (ESPPs): Employees buy company stock at a discount via payroll deduction
- Stock bonus plans: Employer contributes employer stock as the benefit
What is a non-qualified deferred compensation (NQDC) program?
NQDC plans are agreements between an employer and select key employees (executives, highly compensated employees) allowing the employee to defer part of current compensation until a future date.
Key features:
- Usually unfunded: a "mere promise to pay" by the employer; the deferred amounts remain the employer's assets and are subject to the employer's general creditors in bankruptcy
- Governed by Internal Revenue Code (IRC) Section 409A, with strict rules on timing of deferral elections and distribution events
- Contributions do NOT receive the same tax-deferred protection as ERISA qualified plans
- Not subject to ERISA participation, vesting, or funding rules (but must comply with ERISA's reporting and disclosure requirements as a top-hat plan)
Exam Tip: Gotchas
- Non-qualified deferred compensation assets remain the property of the employer and are accessible to the employer's general creditors in bankruptcy. A participant in an NQDC plan has only an unsecured promise to receive future payments.