Quick Answer
ERISA sets minimum standards for private-sector employer-sponsored retirement plans covering eligibility, vesting, funding, fiduciary duty, and reporting. It does NOT cover government plans, church plans, or IRAs. Fiduciaries must act solely in participants' interest under the prudent person standard; violating vesting or fiduciary rules is a heavily tested trap.
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 Plans Does ERISA Cover?
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.
What Are the Core ERISA Protections?
ERISA establishes minimum standards in five key areas:
1. When Must an Employee Be Eligible?
- 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. How Does Vesting Work?
- 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. What Does Funding Require?
- Employers must adequately fund plan obligations
- Particularly important for defined benefit plans where the employer must ensure sufficient assets to pay promised benefits
4. What Is the 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. What Must Be Reported and Disclosed?
- Annual Form 5500 filing with the Department of Labor, reporting the plan's financial condition, investments, and operations
- Summary Plan Description (SPD) must be provided to participants, written in plain language explaining plan benefits, rights, and obligations
What Are the ERISA 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.
What Makes a Plan Top-Heavy?
A plan is top-heavy if more than 60% of assets benefit key employees:
Who Counts as a Key Employee?
- Officers earning above a threshold
- 5%+ owners of the company
- 1%+ owners earning more than $150,000
What Must a Top-Heavy Plan Do?
- 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.
What Should You Check on Exam Day?
- Ruled out ERISA for government plans, church plans, and IRAs before applying any ERISA-based rule.
- Confirmed vesting schedules apply only to employer contributions; the employee's own contributions are always 100% vested immediately.
- Applied the prudent person standard and the no-self-dealing rule whenever a question tests fiduciary duty.
- Recognized a top-heavy plan (60%+ of assets to key employees) triggers minimum contributions and accelerated vesting for non-key employees.