State:

National
What is ERISA? The Employee Retirement Income Security Act (ERISA) was enacted to ensure that employees receive the pension and other benefits promised by their employers. ERISA also incorporates and is tied to Internal Revenue Code (IRC) provisions designed to encourage employers to provide retirement and other benefits to their employees. Most provisions of ERISA and the IRC are intended to ensure that tax-favored pension plans do not favor the highest-paid employees over rank-and-file employees. ERISA has a complex series of rules that cover pension, profit-sharing, stock bonus, and most “welfare benefit plans,” such as health and life insurance. ERISA has created a single federal standard for employee benefits, and it supersedes almost all state laws that affect employee benefit plans. An employer's responsibilities under ERISA vary depending on the type of plan involved.
Compliance with ERISA and related laws is extremely complex. To make matters worse, Congress amends ERISA and other benefit-related laws and the courts issue new decisions interpreting these laws nearly every year. Therefore, an attorney or other professional benefit advisor should be consulted before implementing any benefit plan or plan amendment.
An employer's responsibilities under ERISA vary depending on the type of plan involved. Pension plans, for example, are subject to all rules, including reporting and disclosure, financial management of benefit plan assets, administration of benefit plans, and participation, vesting, and funding requirements. Welfare plans (such as health insurance) need only worry about reporting and disclosure rules and financial management and plan administration standards.
Different parts of ERISA are administered by different Federal agencies. In general, the Internal Revenue Service (IRS) administers the taxation of contributions and benefits. In the retirement plan area, the IRS is responsible for enforcing funding, participation, and vesting standards. The Pension Benefit Guarantee Corporation is in charge of pension insurance provisions. And the Department of Labor (DOL) administers reporting and disclosure and the fiduciary requirements of ERISA that regulate the management of plan assets. Please see the national Benefits Recordkeeping and Disclosures section. There is specific information on 401(k), 403(b), 457, simplified employee pensions, and SIMPLE plans. Please see the national Retirement Savings and Pension Plans section. Several other areas of Federal law also impact employee benefit plans. Please see the national Age Discrimination, national Health Care Insurance, and national Leave of Absence sections.
Many provisions of ERISA are part of the IRC. These tax provisions are the “carrot and stick” of federal government policy to encourage employers to sponsor broad-based employee benefit plans. The “carrot” is tax deductions for employer contributions for certain benefits and tax exemptions for employees receiving particular benefits. The “stick” is the IRS withdrawal of favored tax status if minimum standards are not met. The IRC sets limits on contributions to, and benefits from, tax-favored pension plans. There are also rules designed to prevent many types of employee benefit plans from discriminating in favor of highly paid employees. ERISA gives the DOL and benefit plan participants and beneficiaries easy access to federal courts to enforce the law's reporting and disclosure and fiduciary/asset management requirements and to sue for benefits.
Welfare plans. Under ERISA, the terms “employee welfare benefit plan” and “welfare plan” mean any plan, fund, or program that was established or maintained by an employer or by an employee organization, or by both, to provide:
• Medical, surgical, or hospital care or benefits;
• Benefits in the event of sickness, accident, disability, death, or unemployment;
• Vacation benefits;
• Apprenticeship or other training programs;
• Daycare centers;
• Scholarship funds;
• Prepaid legal services; or
• Any benefit described in the Management Relations Act of 1961 other than pensions (29 U.S.C. Sec. 1002).
Pension plans. Generally, the terms “employee pension benefit plan” and “pension plan” mean any plan, fund, or program that was established or maintained by an employer or by an employee organization, or by both, to the extent that, by its express terms or as a result of surrounding circumstances, such plan, fund, or program--
• Provides retirement income to employees; or
• Results in a deferral of income by employees for periods extending to the termination of covered employment or beyond, regardless of the method of calculating the contributions made to the plan, the method of calculating the benefits under the plan, or the method of distributing benefits from the plan.
Examples of ERISA pension plans include defined benefit plans (traditional pension benefits), cash balance plans, money purchase plans, profit-sharing plans, 401(k) plans, target benefit plans, stock bonus plans, employee stock ownership plans (ESOPs), and nonqualified deferred compensation plans.
Exemption from coverage by ERISA. There are reporting and disclosure exemptions for small unfunded welfare plans. Please see the national Benefits Recordkeeping and Disclosures section. Governmental and church plans, plans established solely to comply with unemployment compensation, workers' compensation, disability insurance laws, and plans that are designed to provide benefits in excess of the deduction limits to certain employees are exempt from ERISA requirements. Unfunded plans maintained “primarily” to provide deferred compensation for a select group of management or highly compensated employees are exempt from the participation and vesting, funding, and fiduciary responsibility requirements of the law. These plans are commonly referred to as top hat plans. They are generally subject (unless some other exemption or partial exemption applies) to the reporting and disclosure and administration and enforcement provisions of ERISA.
ERISA has extensive reporting and disclosure requirements for pension, profit-sharing, stock bonus plans, and most “welfare plans” (i.e., health care, life insurance, prepaid legal services, disability insurance). Forms and documents may have to be filed with the IRS, the DOL, and the Pension Benefit Guaranty Corporation (PBGC). Others go directly to plan participants. Please see the national Benefits Recordkeeping and Disclosures section.
The most important of the ERISA reports is the SPD, which is a basic information package provided to participants and beneficiaries. The regulations require extremely detailed information, including standardized material on employee rights, which must be in “clear and simple English.” Often, much of the information that is to be given to participants is provided by the insurance carrier that ultimately pays the benefits. Please see the national Benefits Recordkeeping and Disclosures section.
The administrator of an individual account plan must furnish a benefit statement at least once each calendar quarter if participants or beneficiaries have the right to direct the investment of assets in their plan accounts. The statement is required at least once each calendar year to participants or beneficiaries who have their own accounts under the plan but do not have the right to direct the investment of assets in that account. Active, vested participants in a defined benefit plan must be provided with a statement at least once every three years or a notice describing the availability of the benefit statement at least once each year. The statement must be written in a manner calculated to be understood by the average plan participant and may be delivered in written, electronic, or other appropriate form to the extent the form is reasonably accessible to the participant or beneficiary. Please see the national Benefits Recordkeeping and Disclosures section.
The Form 5500 Annual Return/Report is a single, streamlined form, plus a variety of attachments, that must be filed electronically. The form is used to satisfy DOL, the IRS, and PBGC annual reporting requirements. The 5500 form is due seven months after the end of the plan year and is filed with the DOL. Filers may request an extension of their deadline by filing Form 5558 with the IRS. Approved copies of the Form 5558 will not be returned to the filer. However, a copy of the extension request that was filed must be attached to Form 5500 when filed. Under certain conditions, filers may also be eligible for extensions relating to an extension of time to file their federal income tax return or presidentially declared disasters. Please see the national Benefits Recordkeeping and Disclosures section.
Benefit plans covered by ERISA must have a reasonable claims procedure that must be set out in the plan's SPD. The description of the claims procedure must include the circumstances that might result in the loss or denial of benefits and the procedure for making a claim for benefits, including the procedures for appealing a claim denial. ERISA requires that claim denials must be in writing and must include a clear explanation of the specific reasons for the denial. The plan document and the SPD must provide a procedure for appealing a denial to an authorized plan official or committee for a full and fair review. Please see the national Benefits Recordkeeping and Disclosures section.
The Affordable Care Act added requirements that health plans and insurers have internal claims and appeals and external review processes. The new requirements do not apply to grandfathered health plans. Please see the national Healthcare Insurance section.
For pension benefit plans and welfare benefit plans other than health and disability plans, initial benefit claims must be answered in 90 days, with a possible extension of another 90 days. Appeals must be filed within 60 days of a denial and be decided within an additional 60 to 120 days. Please see the national Benefits Recordkeeping and Disclosures section.
Health plans. Claims of health plans must be processed much more quickly. The time limits for claims decisions depend on the type of claim. For claims involving urgent care, the decision must be made within 72 hours after the claim is received. Claimants must be informed within 24 hours if an urgent claim is incomplete. Decisions on claims in which receipt of the benefit depends on approval before receiving medical care must be made within 15 days. These claims are called "preservice" claims. The decision period may be extended for 15 days for reasons beyond the plan's control. Decisions on postservice claims (where no prior approval is needed) must be provided within 30 days, subject to the same 15-day extension provision.
Disability plans. Disability plan claims must generally be decided in 45 days, with the possibility of two 30-day extensions for circumstances beyond the plan's control. The final decision on an appeal must be made no later than 45 days after receipt of the claimant's first request for review, unless there are special circumstances.
Appeals. Claimants will have 180 days to appeal a denied claim. Appeals generally must be decided within 72 hours for urgent care claims, 30 days for preservice claims, and 60 days for postservice claims.
ERISA and the tax laws break down retirement plans into two groups--defined benefit plans and defined contribution plans. However, while the tax laws make only these two distinctions, in actuality there are many hybrids. Some plans combine features of both, and some employers sponsor both kinds of plans.
Defined benefit plans are the traditional pension plans that provide a monthly payment upon retirement that is based on factors such as years of service and income. The employer is required to make contributions that an actuary determines are sufficient so that the promised benefit can be paid when due. Complex calculations and extensive records must be kept in order to ensure that defined benefit plans are properly funded. Because many defined benefit plans in major industries have funding problems, the Pension Protection Act (PPA) made major revisions to ERISA's funding requirements. Annual per-participant premiums must be paid to the PBGC to ensure benefits for underfunded terminated plans. In addition, defined benefit pension plans that are less than 90 percent funded are subject to accelerated funding requirements. Each year these plans also have to provide the PBGC with detailed funding and financial information and inform participants about the plan's financial status.
Defined contribution plans do not promise any specific monthly benefit upon retirement. The benefits will depend on the amount of the contribution and how it is invested. Defined contribution plans take many forms. In some cases, the employer makes a fixed contribution each year, usually a percentage of each participant's compensation. In other plans, contributions are conditioned on the employer's having profits. Administering defined contribution plans is much simpler than administering defined benefit plans. The PBGC has no role in regulating defined contribution plans.
One of the most popular and widely offered retirement plan options is cash-or-deferred arrangement (CODA), commonly known as a 401(k) plan, after the section of the IRC that authorizes them. Under a CODA, which is a special type of defined contribution plan, an eligible employee can elect to have the employer make a contribution to the plan or receive the cash. If an employee chooses to defer compensation, it is not subject to income taxation until it is withdrawn.
The annual limit on an employee's elective deferrals can be located at http://www.irs.gov/Retirement-Plans. A plan may provide for the employer to match all, part, or none of an employee's deferrals. Please see the national Retirement Savings and Pension Plans section.
Another retirement benefit plan option is hybrid plans that incorporate different features of both defined benefit and defined contribution plans.
Cash-balance plans. The best known of the hybrid plans is the cash-balance plan, which is a defined benefit plan that includes separate hypothetical accounts for each employee that are similar to defined contribution plan accounts. Benefits are paid either as lump sums or as annuities. The hypothetical account balance makes it easier for an employee to understand the value of the plan, because his or her balance at any given time is expressed as a lump sum. In addition, cash-balance plan accounts are portable, and a terminating participant may roll the lump sum into another plan or an individual retirement account (IRA) upon changing employers. In contrast to traditional defined benefit plans in which benefits accrue slowly at first and then rapidly in later years, cash-balance plan accruals are relatively even over an employee's career. Cash-balance plans may thus be more attractive to today's younger and more mobile workforce who expect to work for short periods for several employers over the duration of their careers.
Other hybrid plans. There are several other main categories of hybrid plans. Other defined benefit hybrids are pension equity plans with benefits based on final average pay and age-weighted percentage credits. Upon termination or retirement, final pay is multiplied by the number of percentage credits to determine a portable lump-sum benefit that may also be distributed as an annuity. Pension equity plans appeal to older workers and persons hired in mid-career. Defined contribution hybrids include target benefit plans in which contributions are actuarially determined to meet benefit targets while still allowing participants to direct the investment of their accounts and to retain the investment risk.
The Internal Revenue Code provides additional retirement plan options, especially for small businesses, including simplified employee pensions (SEPs) and SIMPLE Plans. IRC Sec. 403(b) and Sec. 457 provide for retirement plans that are similar to 401(k) plans for nonprofit organizations, educational institutions, and public employers. Please see the national Retirement Savings and Pension Plans section.
Employees and unions have historically preferred defined benefit plans because they guarantee a predictable benefit upon retirement. Such plans encourage a stable workforce and encourage longevity and loyalty because benefit accruals are usually based on an employee's expected pay during the final few years before retirement. Defined benefit plans also allow for some flexibility in design because the benefit formula can include years of service before the plan was implemented. The plan can reward long-term employees for service before the employer was able to afford a retirement plan. At the same time, the employer is able to maximize its tax deductible contribution to the plan as the past-service credits are paid for.
On the other hand, many employers have moved to defined contribution plans because they are not subject to minimum funding or pension insurance requirements. Contributions can be adjusted depending on profitability, and it is even possible to allow investments in employer stock, thus increasing the interest of individual employees in the employer's economic performance.
Demise of the defined benefit plan? The demise of the defined benefit pension plan started with the increased regulation brought on by the enactment of ERISA in 1974. The continual addition of more layers of regulation have only served to speed up this process. The next nail in the coffin was the advent of the 401(k) plan. Few, if any, of the new technology companies born in the 1980s and 1990s adopted pension plans, with most opting for 401(k) plans. The latest trend is for old-line companies to replace their traditional pensions with 401(k) and similar plans. While it seems inevitable that defined benefit plans will become extinct, the next major test for this trend will come when large numbers of Baby Boomers retire over the next decade and attempt to live on the combination of their Social Security and 401(k) plan benefits.
Effect of PPA. The PPA did nothing to halt the decline of defined benefit plans. On the contrary, it eliminated the legal roadblocks on conversions to hybrid plans. The provisions on 401(k) plans reflect the belief of Congress that 401(k) plans will be the main source of employer-provided retirement benefits in the years ahead.
The Internal Revenue Code IRC provides incentives to encourage small employers to sponsor retirement plans, including a tax credit for plan start-up costs and a determination letter fee waiver.
Start-up cost tax credit. IRC Sec. 45E provides for an annual tax credit (up to $500 per year) to offset a small employer's plan start-up costs during the first three years of a plan's operation. Because many small employers have low profits, the tax deduction available for plan administrative costs often has limited value. The $500 tax credit, however, will get subtracted right off an employer's tax bill. Costs that exceed the credit may then be deducted. The credit is available to employers that, in the preceding year, did not employ more than 100 employees who had compensation of more than $5,000. The credit is not available to an employer that sponsored a retirement plan during the three tax years preceding the first tax year for which the credit would apply. The new plan must have at least one employee eligible to participate who is not a highly compensated employee (HCE).
The credit allowed each year is equal to 50 percent of “qualified start-up costs,” which include ordinary and necessary expenses paid or incurred to establish or administer a plan and to provide retirement-related education to employees with respect to the plan.
Fee waivers. The IRS may not charge user fees for determination letter requests made before the end of the fifth plan year that a small employer plan is in existence or the end of any remedial amendment period beginning within the first five plan years (26 U.S.C. Sec. 7528). The cost and paperwork involved in obtaining initial determination letters and determination letters for the frequently required plan amendments are a major disincentive for small employers to sponsor qualified retirement plans. The fee waiver is limited to employers that have at least one employee participating in the plan who is not a highly compensated employee.
ERISA imposes certain duties on individuals serving in a fiduciary capacity (29 U.S.C. Sec. 1104). These duties include:
• The duty of loyalty;
• The duty to act prudently;
• The duty to diversify plan investments;
• The duty to monitor;
• The duty to follow the plan document; and
• The duty to hold plan assets in trust.
The U.S. Supreme Court has determined that participants in defined contribution plans may sue plan fiduciaries for monetary damages if the value of their individual accounts was reduced by actions or inactions of the fiduciaries that violated ERISA’s fiduciary conduct standards. The high court distinguished the status of a defined contribution plan participant from that of a participant in a defined benefit plan for purposes of determining the type of damages that could be sought in a suit under ERISA Sec. 502(a)(2) for a fiduciary breach. The Court said that its earlier ruling that Sec. 502(a)(2) provided for damages to a plan as a whole and not to an individual participant was applicable to defined benefit plans, but not necessarily to defined contribution plans (LaRue v. DeWolff, Broberg & Associates, 55 U.S. 248 (2008)).
ERISA defines a "fiduciary" as any individual who:
• Exercises discretionary authority or control over the management of an employee benefit plan or exercises any authority or control over management or disposition of an employee benefit plan's assets;
• Renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so; or
• Has discretionary authority or responsibility in the administration of an employee benefit plan (29 U.S.C. Sec. 1002(21)(a)).
ERISA provides that every employee benefit plan must be in writing and must include a procedure for establishing and carrying out a funding policy that is consistent with the objectives of the plan and with ERISA's fiduciary requirements (29 U.S.C. 1102(b)). It is generally accepted that the best way to fulfill this requirement is to have a written investment policy statement (ISP). In fact, a plan's ISP is often the first thing that DOL asks to see when performing an audit.
Purposes. An ISP serves the following purposes:
• It provides a written record of policies, practices, and procedures for making investment decisions.
• It provides a baseline from which to monitor and evaluate investment performance.
• It ensures the continuity of the investment strategy when there is turnover in the membership of the plan committee.
Content. An ISP often includes the following information:
• The purpose and background of the statement;
• Investment objectives;
• Guidelines for investment policy, including risk tolerance, asset class preferences, and a time horizon;
• Security guidelines;
• Guidelines and procedures for the selection of investment managers; and
• Control procedures, including the duties and responsibilities of the investment committee, the duties and responsibilities of the investment managers, and procedures for monitoring the investment managers.
ERISA requires a plan fiduciary to “discharge [its] duties with respect to a plan solely in the interest of the participants and beneficiaries” (29 U.S.C. Sec. 1104). This duty includes providing participants and beneficiaries with information about the “likely future of plan benefits” to help them decide whether to remain with the plan (Varity Corp. v. Howe, 516 U.S. 489, U.S. Sup. Ct., 1996).
ERISA does not specify the standard of review that a trial court should apply in a suit for wrongful denial of benefits. The Supreme Court held that the default standard of review in all benefit claim cases brought under 29 U.S.C. Sec. 1132(a)(1)(B) is de novo (Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 113 (1989)). This means that the Court is to review all of the evidence and make its own fresh determination of whether the denial of benefits was correct or not. The Court noted, however, that when a plan by its terms gives the administrator discretion to decide benefit claims, the administrator’s decision is deferred to unless there is an abuse of that discretion. Thus, where the administrator has been granted the discretion to decide claims and interpret the plan, a suit challenging the administrator's decision or interpretation will generally succeed only if it was “arbitrary and capricious” (for example, that a benefit denial will be reversed only if it makes no sense at all). If there is any reasonable basis for the denial, it will be upheld. The judge is not allowed to substitute his or her own judgment for that of the plan, will not consider if some other line of reasoning is better, and will not reexamine the facts in detail or consider new evidence.
If the plan document does not give the plan administrator discretion to determine eligibility and to interpret the plan, the judge in a suit for benefits will review the case from scratch. This is called a de novo review. The judge will review all the evidence and will make an independent determination of whether the benefit denial was correct.
In the Firestone case, the Supreme Court also ruled that if a benefit plan gives discretion to an administrator who is operating under a conflict of interest, that conflict must be weighed as a factor in determining whether there is an abuse of discretion. The Court has also ruled that there is a conflict of interest when the plan administrator is both evaluating and paying benefit claims. While the existence of such a conflict is clear where the employer itself both funds and decides claims, a conflict also exists where the plan administrator is an insurance company.
The Supreme Court has stated that the significance of a conflict of interest will depend on the circumstances of the particular case. Thus, the existence of a conflict of interest is just one of the factors that a judge should weigh when determining how it should review a benefit denial and how much deference should be given to an administrator's determination.
Practice tip: It is advisable that all ERISA plan documents include language granting the plan administrator discretion to interpret the plan and make benefit eligibility determinations. Documents should be reviewed to ensure that they include such language. It is also advisable when reviewing plan documents to make sure that the summary plan description and the plan documents are consistent and that any ambiguous provisions are clarified.
With certain exceptions, all employees with 1 year of service who are at least 21 years of age must be included in the plan. A year of service is a calendar year, plan year, or any other consecutive 12-month period defined in the plan in which the employee has at least 1,000 hours of service. As an exception to the one-year participation rule, plans may require 2 years of service for participation, but if they do, they must provide 100 percent vesting immediately.
Nonvested participants may have breaks of service away from their employer of up to 5 years without losing any prior service as credit toward both participation and vesting.
General rule. Vesting refers to the percentage of an employee's benefit account that he or she is entitled to retain after leaving the organization. Employees immediately vest in their own contributions and the earnings on them. However, employees do not necessarily have an immediate right to any contributions made by an employer. Federal law provides a maximum number of years a company may require employees to work to earn the vested right to all or some of these benefits.
In a defined benefit plan, there may be:
• 100 percent vesting after five years; or
• 20 percent vesting after three years, plus 20 percent per year thereafter.
Employers have a choice of two different vesting schedules for employer-matching 401(k) contributions:
• An employer may use a schedule in which employees are 100 percent vested in employer contributions after 3 years of service (cliff vesting); or
• Under graduated vesting, an employee must be at least 20 percent vested after 2 years, 40 percent after three years, 60 percent after 4 years, 80 percent after 5 years, and 100 percent after 6 years.
If an automatic enrollment 401(k) plan requires employer contributions, employees vest in those contributions after 2 years. Automatic enrollment 401(k) plans with optional matching contributions follow one of the vesting schedules above.
The contributions or benefits provided under a retirement plan must not discriminate in favor of highly compensated employees. IRC Section 401(a)(4) contains the test for nondiscrimination that a qualified plan must satisfy. The purpose of this test is to ensure that the benefits provided to highly compensated employees are proportional to those provided to nonhighly compensated employees.
In order to protect surviving spouses, defined benefit plans, money purchase pension plans, and target benefit plans must pay benefits in the form of a qualified joint and survivor annuity (QJSA) or qualified preretirement survivor annuity (QPSA) if the participant dies before annuity payments may begin. A QJSA or QPSA is required unless the participant, with the consent of the spouse, elects another form of benefit.
QJSA requirements. A QJSA is an annuity for the life of the participant, with a survivor annuity for the life of the participant's spouse. The amount paid to the surviving spouse must be no less than 50 percent and no greater than 100 percent of the amount of the annuity paid during the participant’s life.
QOSAs. A participant who waives a QJSA may elect to have a qualified optional survivor annuity (QOSA). The amount paid to the surviving spouse under a QOSA is equal to the certain percentage (as chosen) of the amount of the annuity payable during the participant’s life.
QPSA requirements. A QPSA is a form of a death benefit paid as a life annuity to the surviving spouse of a participant who was vested in his or her retirement plan benefits, died before retirement, and was married to the surviving spouse (for at least one year if the plan so provides).
Notice requirements. A QJSA notice generally must be given to plan participants in certain retirement plans that contain a QJSA feature. Such notice must be given between 30 and 180 days before the date benefits are paid.
A QOSA notice must be given to plan participants in certain retirement plans that contain a QOSA feature. It is given between 30 and 180 days before the date benefits are paid.
A QPSA notice must be given to a participant during the time beginning when he or she is age 32 and ending with the close of the plan year before the participant is age 35 or within 1 year from when an employee becomes a plan participant if he or she is hired after the age of 35. It is given in certain retirement plans that contain a QPSA feature.
What happens to employees' retirement benefits when they leave a job before they retire?
Employees in defined benefit plans (other than cash balance plans) will most likely be required to leave the benefits with the retirement plan until they become eligible to receive them.
Employees in cash balance plans will probably have the option of transferring at least a portion of the account balance to an IRA or to a new employer’s plan.
In most cases, employees in defined contribution plans (e.g., 401(k)s) who leave an employer before retirement age will be able to transfer their account balance out of their employer’s plan. Generally they can choose:
• A lump sum;
• A rollover to another retirement plan; or
• A rollover to an IRA.
If an employee’s account balance is less than $5,000 when he or she leaves an employer, the plan can make an immediate distribution without the employee’s consent. If this distribution is more than $1,000, the plan must automatically roll the funds into an IRA it selects, unless the employee elects to receive a lump-sum payment or to roll it over into an IRA of his or her choice. The plan must first send the employee a notice allowing him or her to make other arrangements, and it must follow rules regarding what type of IRA can be used.
ERISA generally bars retirement plans from paying benefits to a third party, even under court order. This means that a creditor cannot attach an employee's pension and get a court order requiring it to be paid to the creditor. There is, however, an exception for a QDRO.
A QDRO is a judgment, decree, or order for a retirement plan to pay child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of a participant. The QDRO must contain certain specific information, such as:
• The participant and each alternate payee’s name and last known mailing address; and
• The amount or percentage of the participant's benefits to be paid to each alternate payee.
A QDRO may not award an amount or form of benefit that is not available under the plan.
A spouse or former spouse who receives QDRO benefits from a retirement plan reports the payments received as if he or she were a plan participant. The spouse or former spouse is allocated a share of the participant's cost (investment in the contract) equal to the cost times a fraction. The numerator of the fraction is the present value of the benefits payable to the spouse or former spouse. The denominator is the present value of all benefits payable to the participant.
A QDRO distribution that is paid to a child or other dependent is taxed to the plan participant.
There is a dollar limit on the amount that may be contributed each year to an individual employee's account in a tax-qualified defined contribution plan. This amount is indexed for inflation.
Warning: The contribution and benefit limits and the nondiscrimination rules are very complex. It is easy for a plan to inadvertently run afoul of the rules with dire tax consequences for both the employer and the employees. Employers should have a benefits expert evaluate the design and operation of their qualified retirement plans in light of the new limits. This advice is particularly relevant to 401(k) plans because of the special nondiscrimination rules and contribution limits that apply to these plans.
Last reviewed on February 22, 2017.
Related Topics:
National
What is ERISA? The Employee Retirement Income Security Act (ERISA) was enacted to ensure that employees receive the pension and other benefits promised by their employers. ERISA also incorporates and is tied to Internal Revenue Code (IRC) provisions designed to encourage employers to provide retirement and other benefits to their employees. Most provisions of ERISA and the IRC are intended to ensure that tax-favored pension plans do not favor the highest-paid employees over rank-and-file employees. ERISA has a complex series of rules that cover pension, profit-sharing, stock bonus, and most “welfare benefit plans,” such as health and life insurance. ERISA has created a single federal standard for employee benefits, and it supersedes almost all state laws that affect employee benefit plans. An employer's responsibilities under ERISA vary depending on the type of plan involved.
Compliance with ERISA and related laws is extremely complex. To make matters worse, Congress amends ERISA and other benefit-related laws and the courts issue new decisions interpreting these laws nearly every year. Therefore, an attorney or other professional benefit advisor should be consulted before implementing any benefit plan or plan amendment.
An employer's responsibilities under ERISA vary depending on the type of plan involved. Pension plans, for example, are subject to all rules, including reporting and disclosure, financial management of benefit plan assets, administration of benefit plans, and participation, vesting, and funding requirements. Welfare plans (such as health insurance) need only worry about reporting and disclosure rules and financial management and plan administration standards.
Different parts of ERISA are administered by different Federal agencies. In general, the Internal Revenue Service (IRS) administers the taxation of contributions and benefits. In the retirement plan area, the IRS is responsible for enforcing funding, participation, and vesting standards. The Pension Benefit Guarantee Corporation is in charge of pension insurance provisions. And the Department of Labor (DOL) administers reporting and disclosure and the fiduciary requirements of ERISA that regulate the management of plan assets. Please see the national Benefits Recordkeeping and Disclosures section. There is specific information on 401(k), 403(b), 457, simplified employee pensions, and SIMPLE plans. Please see the national Retirement Savings and Pension Plans section. Several other areas of Federal law also impact employee benefit plans. Please see the national Age Discrimination, national Health Care Insurance, and national Leave of Absence sections.
Many provisions of ERISA are part of the IRC. These tax provisions are the “carrot and stick” of federal government policy to encourage employers to sponsor broad-based employee benefit plans. The “carrot” is tax deductions for employer contributions for certain benefits and tax exemptions for employees receiving particular benefits. The “stick” is the IRS withdrawal of favored tax status if minimum standards are not met. The IRC sets limits on contributions to, and benefits from, tax-favored pension plans. There are also rules designed to prevent many types of employee benefit plans from discriminating in favor of highly paid employees. ERISA gives the DOL and benefit plan participants and beneficiaries easy access to federal courts to enforce the law's reporting and disclosure and fiduciary/asset management requirements and to sue for benefits.
Welfare plans. Under ERISA, the terms “employee welfare benefit plan” and “welfare plan” mean any plan, fund, or program that was established or maintained by an employer or by an employee organization, or by both, to provide:
• Medical, surgical, or hospital care or benefits;
• Benefits in the event of sickness, accident, disability, death, or unemployment;
• Vacation benefits;
• Apprenticeship or other training programs;
• Daycare centers;
• Scholarship funds;
• Prepaid legal services; or
• Any benefit described in the Management Relations Act of 1961 other than pensions (29 U.S.C. Sec. 1002).
Pension plans. Generally, the terms “employee pension benefit plan” and “pension plan” mean any plan, fund, or program that was established or maintained by an employer or by an employee organization, or by both, to the extent that, by its express terms or as a result of surrounding circumstances, such plan, fund, or program--
• Provides retirement income to employees; or
• Results in a deferral of income by employees for periods extending to the termination of covered employment or beyond, regardless of the method of calculating the contributions made to the plan, the method of calculating the benefits under the plan, or the method of distributing benefits from the plan.
Examples of ERISA pension plans include defined benefit plans (traditional pension benefits), cash balance plans, money purchase plans, profit-sharing plans, 401(k) plans, target benefit plans, stock bonus plans, employee stock ownership plans (ESOPs), and nonqualified deferred compensation plans.
Exemption from coverage by ERISA. There are reporting and disclosure exemptions for small unfunded welfare plans. Please see the national Benefits Recordkeeping and Disclosures section. Governmental and church plans, plans established solely to comply with unemployment compensation, workers' compensation, disability insurance laws, and plans that are designed to provide benefits in excess of the deduction limits to certain employees are exempt from ERISA requirements. Unfunded plans maintained “primarily” to provide deferred compensation for a select group of management or highly compensated employees are exempt from the participation and vesting, funding, and fiduciary responsibility requirements of the law. These plans are commonly referred to as top hat plans. They are generally subject (unless some other exemption or partial exemption applies) to the reporting and disclosure and administration and enforcement provisions of ERISA.
ERISA has extensive reporting and disclosure requirements for pension, profit-sharing, stock bonus plans, and most “welfare plans” (i.e., health care, life insurance, prepaid legal services, disability insurance). Forms and documents may have to be filed with the IRS, the DOL, and the Pension Benefit Guaranty Corporation (PBGC). Others go directly to plan participants. Please see the national Benefits Recordkeeping and Disclosures section.
The most important of the ERISA reports is the SPD, which is a basic information package provided to participants and beneficiaries. The regulations require extremely detailed information, including standardized material on employee rights, which must be in “clear and simple English.” Often, much of the information that is to be given to participants is provided by the insurance carrier that ultimately pays the benefits. Please see the national Benefits Recordkeeping and Disclosures section.
The administrator of an individual account plan must furnish a benefit statement at least once each calendar quarter if participants or beneficiaries have the right to direct the investment of assets in their plan accounts. The statement is required at least once each calendar year to participants or beneficiaries who have their own accounts under the plan but do not have the right to direct the investment of assets in that account. Active, vested participants in a defined benefit plan must be provided with a statement at least once every three years or a notice describing the availability of the benefit statement at least once each year. The statement must be written in a manner calculated to be understood by the average plan participant and may be delivered in written, electronic, or other appropriate form to the extent the form is reasonably accessible to the participant or beneficiary. Please see the national Benefits Recordkeeping and Disclosures section.
The Form 5500 Annual Return/Report is a single, streamlined form, plus a variety of attachments, that must be filed electronically. The form is used to satisfy DOL, the IRS, and PBGC annual reporting requirements. The 5500 form is due seven months after the end of the plan year and is filed with the DOL. Filers may request an extension of their deadline by filing Form 5558 with the IRS. Approved copies of the Form 5558 will not be returned to the filer. However, a copy of the extension request that was filed must be attached to Form 5500 when filed. Under certain conditions, filers may also be eligible for extensions relating to an extension of time to file their federal income tax return or presidentially declared disasters. Please see the national Benefits Recordkeeping and Disclosures section.
Benefit plans covered by ERISA must have a reasonable claims procedure that must be set out in the plan's SPD. The description of the claims procedure must include the circumstances that might result in the loss or denial of benefits and the procedure for making a claim for benefits, including the procedures for appealing a claim denial. ERISA requires that claim denials must be in writing and must include a clear explanation of the specific reasons for the denial. The plan document and the SPD must provide a procedure for appealing a denial to an authorized plan official or committee for a full and fair review. Please see the national Benefits Recordkeeping and Disclosures section.
The Affordable Care Act added requirements that health plans and insurers have internal claims and appeals and external review processes. The new requirements do not apply to grandfathered health plans. Please see the national Healthcare Insurance section.
For pension benefit plans and welfare benefit plans other than health and disability plans, initial benefit claims must be answered in 90 days, with a possible extension of another 90 days. Appeals must be filed within 60 days of a denial and be decided within an additional 60 to 120 days. Please see the national Benefits Recordkeeping and Disclosures section.
Health plans. Claims of health plans must be processed much more quickly. The time limits for claims decisions depend on the type of claim. For claims involving urgent care, the decision must be made within 72 hours after the claim is received. Claimants must be informed within 24 hours if an urgent claim is incomplete. Decisions on claims in which receipt of the benefit depends on approval before receiving medical care must be made within 15 days. These claims are called "preservice" claims. The decision period may be extended for 15 days for reasons beyond the plan's control. Decisions on postservice claims (where no prior approval is needed) must be provided within 30 days, subject to the same 15-day extension provision.
Disability plans. Disability plan claims must generally be decided in 45 days, with the possibility of two 30-day extensions for circumstances beyond the plan's control. The final decision on an appeal must be made no later than 45 days after receipt of the claimant's first request for review, unless there are special circumstances.
Appeals. Claimants will have 180 days to appeal a denied claim. Appeals generally must be decided within 72 hours for urgent care claims, 30 days for preservice claims, and 60 days for postservice claims.
ERISA and the tax laws break down retirement plans into two groups--defined benefit plans and defined contribution plans. However, while the tax laws make only these two distinctions, in actuality there are many hybrids. Some plans combine features of both, and some employers sponsor both kinds of plans.
Defined benefit plans are the traditional pension plans that provide a monthly payment upon retirement that is based on factors such as years of service and income. The employer is required to make contributions that an actuary determines are sufficient so that the promised benefit can be paid when due. Complex calculations and extensive records must be kept in order to ensure that defined benefit plans are properly funded. Because many defined benefit plans in major industries have funding problems, the Pension Protection Act (PPA) made major revisions to ERISA's funding requirements. Annual per-participant premiums must be paid to the PBGC to ensure benefits for underfunded terminated plans. In addition, defined benefit pension plans that are less than 90 percent funded are subject to accelerated funding requirements. Each year these plans also have to provide the PBGC with detailed funding and financial information and inform participants about the plan's financial status.
Defined contribution plans do not promise any specific monthly benefit upon retirement. The benefits will depend on the amount of the contribution and how it is invested. Defined contribution plans take many forms. In some cases, the employer makes a fixed contribution each year, usually a percentage of each participant's compensation. In other plans, contributions are conditioned on the employer's having profits. Administering defined contribution plans is much simpler than administering defined benefit plans. The PBGC has no role in regulating defined contribution plans.
One of the most popular and widely offered retirement plan options is cash-or-deferred arrangement (CODA), commonly known as a 401(k) plan, after the section of the IRC that authorizes them. Under a CODA, which is a special type of defined contribution plan, an eligible employee can elect to have the employer make a contribution to the plan or receive the cash. If an employee chooses to defer compensation, it is not subject to income taxation until it is withdrawn.
The annual limit on an employee's elective deferrals can be located at http://www.irs.gov/Retirement-Plans. A plan may provide for the employer to match all, part, or none of an employee's deferrals. Please see the national Retirement Savings and Pension Plans section.
Another retirement benefit plan option is hybrid plans that incorporate different features of both defined benefit and defined contribution plans.
Cash-balance plans. The best known of the hybrid plans is the cash-balance plan, which is a defined benefit plan that includes separate hypothetical accounts for each employee that are similar to defined contribution plan accounts. Benefits are paid either as lump sums or as annuities. The hypothetical account balance makes it easier for an employee to understand the value of the plan, because his or her balance at any given time is expressed as a lump sum. In addition, cash-balance plan accounts are portable, and a terminating participant may roll the lump sum into another plan or an individual retirement account (IRA) upon changing employers. In contrast to traditional defined benefit plans in which benefits accrue slowly at first and then rapidly in later years, cash-balance plan accruals are relatively even over an employee's career. Cash-balance plans may thus be more attractive to today's younger and more mobile workforce who expect to work for short periods for several employers over the duration of their careers.
Other hybrid plans. There are several other main categories of hybrid plans. Other defined benefit hybrids are pension equity plans with benefits based on final average pay and age-weighted percentage credits. Upon termination or retirement, final pay is multiplied by the number of percentage credits to determine a portable lump-sum benefit that may also be distributed as an annuity. Pension equity plans appeal to older workers and persons hired in mid-career. Defined contribution hybrids include target benefit plans in which contributions are actuarially determined to meet benefit targets while still allowing participants to direct the investment of their accounts and to retain the investment risk.
The Internal Revenue Code provides additional retirement plan options, especially for small businesses, including simplified employee pensions (SEPs) and SIMPLE Plans. IRC Sec. 403(b) and Sec. 457 provide for retirement plans that are similar to 401(k) plans for nonprofit organizations, educational institutions, and public employers. Please see the national Retirement Savings and Pension Plans section.
Employees and unions have historically preferred defined benefit plans because they guarantee a predictable benefit upon retirement. Such plans encourage a stable workforce and encourage longevity and loyalty because benefit accruals are usually based on an employee's expected pay during the final few years before retirement. Defined benefit plans also allow for some flexibility in design because the benefit formula can include years of service before the plan was implemented. The plan can reward long-term employees for service before the employer was able to afford a retirement plan. At the same time, the employer is able to maximize its tax deductible contribution to the plan as the past-service credits are paid for.
On the other hand, many employers have moved to defined contribution plans because they are not subject to minimum funding or pension insurance requirements. Contributions can be adjusted depending on profitability, and it is even possible to allow investments in employer stock, thus increasing the interest of individual employees in the employer's economic performance.
Demise of the defined benefit plan? The demise of the defined benefit pension plan started with the increased regulation brought on by the enactment of ERISA in 1974. The continual addition of more layers of regulation have only served to speed up this process. The next nail in the coffin was the advent of the 401(k) plan. Few, if any, of the new technology companies born in the 1980s and 1990s adopted pension plans, with most opting for 401(k) plans. The latest trend is for old-line companies to replace their traditional pensions with 401(k) and similar plans. While it seems inevitable that defined benefit plans will become extinct, the next major test for this trend will come when large numbers of Baby Boomers retire over the next decade and attempt to live on the combination of their Social Security and 401(k) plan benefits.
Effect of PPA. The PPA did nothing to halt the decline of defined benefit plans. On the contrary, it eliminated the legal roadblocks on conversions to hybrid plans. The provisions on 401(k) plans reflect the belief of Congress that 401(k) plans will be the main source of employer-provided retirement benefits in the years ahead.
The Internal Revenue Code IRC provides incentives to encourage small employers to sponsor retirement plans, including a tax credit for plan start-up costs and a determination letter fee waiver.
Start-up cost tax credit. IRC Sec. 45E provides for an annual tax credit (up to $500 per year) to offset a small employer's plan start-up costs during the first three years of a plan's operation. Because many small employers have low profits, the tax deduction available for plan administrative costs often has limited value. The $500 tax credit, however, will get subtracted right off an employer's tax bill. Costs that exceed the credit may then be deducted. The credit is available to employers that, in the preceding year, did not employ more than 100 employees who had compensation of more than $5,000. The credit is not available to an employer that sponsored a retirement plan during the three tax years preceding the first tax year for which the credit would apply. The new plan must have at least one employee eligible to participate who is not a highly compensated employee (HCE).
The credit allowed each year is equal to 50 percent of “qualified start-up costs,” which include ordinary and necessary expenses paid or incurred to establish or administer a plan and to provide retirement-related education to employees with respect to the plan.
Fee waivers. The IRS may not charge user fees for determination letter requests made before the end of the fifth plan year that a small employer plan is in existence or the end of any remedial amendment period beginning within the first five plan years (26 U.S.C. Sec. 7528). The cost and paperwork involved in obtaining initial determination letters and determination letters for the frequently required plan amendments are a major disincentive for small employers to sponsor qualified retirement plans. The fee waiver is limited to employers that have at least one employee participating in the plan who is not a highly compensated employee.
ERISA imposes certain duties on individuals serving in a fiduciary capacity (29 U.S.C. Sec. 1104). These duties include:
• The duty of loyalty;
• The duty to act prudently;
• The duty to diversify plan investments;
• The duty to monitor;
• The duty to follow the plan document; and
• The duty to hold plan assets in trust.
The U.S. Supreme Court has determined that participants in defined contribution plans may sue plan fiduciaries for monetary damages if the value of their individual accounts was reduced by actions or inactions of the fiduciaries that violated ERISA’s fiduciary conduct standards. The high court distinguished the status of a defined contribution plan participant from that of a participant in a defined benefit plan for purposes of determining the type of damages that could be sought in a suit under ERISA Sec. 502(a)(2) for a fiduciary breach. The Court said that its earlier ruling that Sec. 502(a)(2) provided for damages to a plan as a whole and not to an individual participant was applicable to defined benefit plans, but not necessarily to defined contribution plans (LaRue v. DeWolff, Broberg & Associates, 55 U.S. 248 (2008)).
ERISA defines a "fiduciary" as any individual who:
• Exercises discretionary authority or control over the management of an employee benefit plan or exercises any authority or control over management or disposition of an employee benefit plan's assets;
• Renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so; or
• Has discretionary authority or responsibility in the administration of an employee benefit plan (29 U.S.C. Sec. 1002(21)(a)).
ERISA provides that every employee benefit plan must be in writing and must include a procedure for establishing and carrying out a funding policy that is consistent with the objectives of the plan and with ERISA's fiduciary requirements (29 U.S.C. 1102(b)). It is generally accepted that the best way to fulfill this requirement is to have a written investment policy statement (ISP). In fact, a plan's ISP is often the first thing that DOL asks to see when performing an audit.
Purposes. An ISP serves the following purposes:
• It provides a written record of policies, practices, and procedures for making investment decisions.
• It provides a baseline from which to monitor and evaluate investment performance.
• It ensures the continuity of the investment strategy when there is turnover in the membership of the plan committee.
Content. An ISP often includes the following information:
• The purpose and background of the statement;
• Investment objectives;
• Guidelines for investment policy, including risk tolerance, asset class preferences, and a time horizon;
• Security guidelines;
• Guidelines and procedures for the selection of investment managers; and
• Control procedures, including the duties and responsibilities of the investment committee, the duties and responsibilities of the investment managers, and procedures for monitoring the investment managers.
ERISA requires a plan fiduciary to “discharge [its] duties with respect to a plan solely in the interest of the participants and beneficiaries” (29 U.S.C. Sec. 1104). This duty includes providing participants and beneficiaries with information about the “likely future of plan benefits” to help them decide whether to remain with the plan (Varity Corp. v. Howe, 516 U.S. 489, U.S. Sup. Ct., 1996).
ERISA does not specify the standard of review that a trial court should apply in a suit for wrongful denial of benefits. The Supreme Court held that the default standard of review in all benefit claim cases brought under 29 U.S.C. Sec. 1132(a)(1)(B) is de novo (Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101, 113 (1989)). This means that the Court is to review all of the evidence and make its own fresh determination of whether the denial of benefits was correct or not. The Court noted, however, that when a plan by its terms gives the administrator discretion to decide benefit claims, the administrator’s decision is deferred to unless there is an abuse of that discretion. Thus, where the administrator has been granted the discretion to decide claims and interpret the plan, a suit challenging the administrator's decision or interpretation will generally succeed only if it was “arbitrary and capricious” (for example, that a benefit denial will be reversed only if it makes no sense at all). If there is any reasonable basis for the denial, it will be upheld. The judge is not allowed to substitute his or her own judgment for that of the plan, will not consider if some other line of reasoning is better, and will not reexamine the facts in detail or consider new evidence.
If the plan document does not give the plan administrator discretion to determine eligibility and to interpret the plan, the judge in a suit for benefits will review the case from scratch. This is called a de novo review. The judge will review all the evidence and will make an independent determination of whether the benefit denial was correct.
In the Firestone case, the Supreme Court also ruled that if a benefit plan gives discretion to an administrator who is operating under a conflict of interest, that conflict must be weighed as a factor in determining whether there is an abuse of discretion. The Court has also ruled that there is a conflict of interest when the plan administrator is both evaluating and paying benefit claims. While the existence of such a conflict is clear where the employer itself both funds and decides claims, a conflict also exists where the plan administrator is an insurance company.
The Supreme Court has stated that the significance of a conflict of interest will depend on the circumstances of the particular case. Thus, the existence of a conflict of interest is just one of the factors that a judge should weigh when determining how it should review a benefit denial and how much deference should be given to an administrator's determination.
Practice tip: It is advisable that all ERISA plan documents include language granting the plan administrator discretion to interpret the plan and make benefit eligibility determinations. Documents should be reviewed to ensure that they include such language. It is also advisable when reviewing plan documents to make sure that the summary plan description and the plan documents are consistent and that any ambiguous provisions are clarified.
With certain exceptions, all employees with 1 year of service who are at least 21 years of age must be included in the plan. A year of service is a calendar year, plan year, or any other consecutive 12-month period defined in the plan in which the employee has at least 1,000 hours of service. As an exception to the one-year participation rule, plans may require 2 years of service for participation, but if they do, they must provide 100 percent vesting immediately.
Nonvested participants may have breaks of service away from their employer of up to 5 years without losing any prior service as credit toward both participation and vesting.
General rule. Vesting refers to the percentage of an employee's benefit account that he or she is entitled to retain after leaving the organization. Employees immediately vest in their own contributions and the earnings on them. However, employees do not necessarily have an immediate right to any contributions made by an employer. Federal law provides a maximum number of years a company may require employees to work to earn the vested right to all or some of these benefits.
In a defined benefit plan, there may be:
• 100 percent vesting after five years; or
• 20 percent vesting after three years, plus 20 percent per year thereafter.
Employers have a choice of two different vesting schedules for employer-matching 401(k) contributions:
• An employer may use a schedule in which employees are 100 percent vested in employer contributions after 3 years of service (cliff vesting); or
• Under graduated vesting, an employee must be at least 20 percent vested after 2 years, 40 percent after three years, 60 percent after 4 years, 80 percent after 5 years, and 100 percent after 6 years.
If an automatic enrollment 401(k) plan requires employer contributions, employees vest in those contributions after 2 years. Automatic enrollment 401(k) plans with optional matching contributions follow one of the vesting schedules above.
The contributions or benefits provided under a retirement plan must not discriminate in favor of highly compensated employees. IRC Section 401(a)(4) contains the test for nondiscrimination that a qualified plan must satisfy. The purpose of this test is to ensure that the benefits provided to highly compensated employees are proportional to those provided to nonhighly compensated employees.
In order to protect surviving spouses, defined benefit plans, money purchase pension plans, and target benefit plans must pay benefits in the form of a qualified joint and survivor annuity (QJSA) or qualified preretirement survivor annuity (QPSA) if the participant dies before annuity payments may begin. A QJSA or QPSA is required unless the participant, with the consent of the spouse, elects another form of benefit.
QJSA requirements. A QJSA is an annuity for the life of the participant, with a survivor annuity for the life of the participant's spouse. The amount paid to the surviving spouse must be no less than 50 percent and no greater than 100 percent of the amount of the annuity paid during the participant’s life.
QOSAs. A participant who waives a QJSA may elect to have a qualified optional survivor annuity (QOSA). The amount paid to the surviving spouse under a QOSA is equal to the certain percentage (as chosen) of the amount of the annuity payable during the participant’s life.
QPSA requirements. A QPSA is a form of a death benefit paid as a life annuity to the surviving spouse of a participant who was vested in his or her retirement plan benefits, died before retirement, and was married to the surviving spouse (for at least one year if the plan so provides).
Notice requirements. A QJSA notice generally must be given to plan participants in certain retirement plans that contain a QJSA feature. Such notice must be given between 30 and 180 days before the date benefits are paid.
A QOSA notice must be given to plan participants in certain retirement plans that contain a QOSA feature. It is given between 30 and 180 days before the date benefits are paid.
A QPSA notice must be given to a participant during the time beginning when he or she is age 32 and ending with the close of the plan year before the participant is age 35 or within 1 year from when an employee becomes a plan participant if he or she is hired after the age of 35. It is given in certain retirement plans that contain a QPSA feature.
What happens to employees' retirement benefits when they leave a job before they retire?
Employees in defined benefit plans (other than cash balance plans) will most likely be required to leave the benefits with the retirement plan until they become eligible to receive them.
Employees in cash balance plans will probably have the option of transferring at least a portion of the account balance to an IRA or to a new employer’s plan.
In most cases, employees in defined contribution plans (e.g., 401(k)s) who leave an employer before retirement age will be able to transfer their account balance out of their employer’s plan. Generally they can choose:
• A lump sum;
• A rollover to another retirement plan; or
• A rollover to an IRA.
If an employee’s account balance is less than $5,000 when he or she leaves an employer, the plan can make an immediate distribution without the employee’s consent. If this distribution is more than $1,000, the plan must automatically roll the funds into an IRA it selects, unless the employee elects to receive a lump-sum payment or to roll it over into an IRA of his or her choice. The plan must first send the employee a notice allowing him or her to make other arrangements, and it must follow rules regarding what type of IRA can be used.
ERISA generally bars retirement plans from paying benefits to a third party, even under court order. This means that a creditor cannot attach an employee's pension and get a court order requiring it to be paid to the creditor. There is, however, an exception for a QDRO.
A QDRO is a judgment, decree, or order for a retirement plan to pay child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of a participant. The QDRO must contain certain specific information, such as:
• The participant and each alternate payee’s name and last known mailing address; and
• The amount or percentage of the participant's benefits to be paid to each alternate payee.
A QDRO may not award an amount or form of benefit that is not available under the plan.
A spouse or former spouse who receives QDRO benefits from a retirement plan reports the payments received as if he or she were a plan participant. The spouse or former spouse is allocated a share of the participant's cost (investment in the contract) equal to the cost times a fraction. The numerator of the fraction is the present value of the benefits payable to the spouse or former spouse. The denominator is the present value of all benefits payable to the participant.
A QDRO distribution that is paid to a child or other dependent is taxed to the plan participant.
There is a dollar limit on the amount that may be contributed each year to an individual employee's account in a tax-qualified defined contribution plan. This amount is indexed for inflation.
Warning: The contribution and benefit limits and the nondiscrimination rules are very complex. It is easy for a plan to inadvertently run afoul of the rules with dire tax consequences for both the employer and the employees. Employers should have a benefits expert evaluate the design and operation of their qualified retirement plans in light of the new limits. This advice is particularly relevant to 401(k) plans because of the special nondiscrimination rules and contribution limits that apply to these plans.
Last reviewed on February 22, 2017.
CT-WEB06
Copyright © 2017 Business & Legal Resources. All rights reserved. 800-727-5257
This document was published on http://Compensation.BLR.com
Document URL: http://compensation.blr.com/analysis/Retirement-Planning/ERISA/