ERISA Requirements
The Employee Retirement Income Security Act of 1974 (ERISA) sets the rules that govern private-sector employer-sponsored retirement plans. Understanding what ERISA requires, and what plans it covers, is essential for the exam.
What ERISA Covers
ERISA applies to private-sector employer-sponsored retirement plans:
- 401(k) plans
- Defined benefit (pension) plans
- Profit-sharing plans
- Money purchase pension plans
ERISA does NOT apply to:
- Government plans (state and local government employee plans, including 457(b) plans)
- Church plans (unless they elect coverage)
- IRAs (individual retirement accounts are not employer-sponsored plans subject to ERISA)
Exam Tip: Gotchas
- ERISA does NOT apply to government plans or church plans. If a question involves a state employee's 457(b) or a municipal pension, ERISA does not govern that plan. ERISA only covers private-sector employer-sponsored plans.
Core ERISA Protections
ERISA establishes minimum standards in five key areas:
1. Eligibility
- Employees must generally be eligible after 1 year of service and reaching age 21
- Plans cannot impose stricter eligibility requirements (but can be more generous)
2. Vesting
- Employees must become vested in employer contributions according to an approved schedule
- Employee's own contributions are always 100% vested immediately
- Vesting schedules apply only to employer contributions
3. Funding
- Employers must adequately fund plan obligations
- Particularly important for defined benefit plans where the employer must ensure sufficient assets to pay promised benefits
4. Fiduciary Duty
- Plan fiduciaries must act solely in the interest of participants and beneficiaries
- Must follow the prudent person standard: act with the care, skill, and diligence a prudent person would use
- Must diversify investments to minimize the risk of large losses
- Cannot engage in prohibited transactions (self-dealing)
5. Reporting and Disclosure
- Annual Form 5500 filing with the Department of Labor
- Summary Plan Description (SPD) must be provided to participants, written in plain language explaining plan benefits, rights, and obligations
Vesting Schedules
ERISA allows two vesting schedules for employer contributions:
| Schedule | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 |
|---|---|---|---|---|---|---|
| Cliff vesting | 0% | 0% | 100% | - | - | - |
| Graded vesting | 0% | 20% | 40% | 60% | 80% | 100% |
- Cliff vesting: 0% until year 3, then 100% all at once
- Graded vesting: 20% per year starting in year 2, reaching 100% in year 6
- Employee's own contributions (including 401(k) elective deferrals) are always 100% vested immediately
Exam Tip: Gotchas
- Employee's OWN contributions (including 401(k) deferrals) are always 100% vested immediately. Vesting schedules only apply to employer contributions.
- Cliff vesting means 0% until year 3, then 100%. Do not confuse this with graded vesting, where vesting increases annually.
Top-Heavy Plans
A plan is top-heavy if more than 60% of assets benefit key employees:
Key Employees Include:
- Officers earning above a threshold
- 5%+ owners of the company
- 1%+ owners earning more than $150,000
Top-Heavy Plan Requirements:
- Must provide minimum contributions (generally 3% of compensation) to non-key employees
- Must use accelerated vesting schedules (either 3-year cliff or 2-6 year graded)
Exam Tip: Gotchas
- Top-heavy threshold is 60% of assets benefiting key employees. If a question describes a plan where most benefits go to owners and officers, think top-heavy.
- Top-heavy plans require minimum 3% contributions to non-key employees. This protects rank-and-file workers when a plan disproportionately benefits key employees.