Employee Retirement Income Security Act (ERISA) - Explained

What is ERISA?

Updated at April 6th, 2023

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What is the Employee Retirement Income Security Act?

The Employee Retirement Income Security Act (ERISA) was passed to protect employees rights with regard to pension, retirement, and other benefit plans offered or provided by employers. Portions of the plan are administered by the Department of Labor, the Internal Revenue Service, and the Employee Benefits Security Administration.

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What Does ERISA Do?

Important provision of ERISA include:

Disclosure and Reporting - Title I establishes disclosure and reporting requirements for sponsors of pension and benefit plans.

Fiduciary Standards - The Act establishes fiduciary standards for administrators of pension and benefit plans.

Insurance Benefits - Title IV requires certain employers to pay premiums to the Pension Benefit Guaranty Corporation, which is an insurance fund to secure certain retirement benefit plans.

Importantly, ERISA does not require employers to offer any particular benefits or pension plan; rather, it applies the above rules to employers who voluntarily provide such plans to employees.

What are the Types of Pension Plans?

There are two basic categories of pension plan covered under ERISA.

Defined Benefit Plan - A defined benefit plan provides recurring payments to an employee upon retirement. The amount of payment is calculated using a formula based upon the years of service and the employees salary during a specified period prior to retirement. The payments generally continue for the remainder of the employee s life.

Defined Contribution Plan - A defined contribution plan allows an employee to make contributions to a retirement account. The employer generally matches a portion of these contributions. The fund is invested to allow growth (often on a tax-free basis) until the time of retirement. The employee may then withdraw any amount of the funds at any time. Early withdrawal of retirement funds generally results in a penalty to the employee. The funds are taxed at the employees marginal tax rate at the time of withdrawal.

Where are the ERISA Protections?

The three primary protections afforded employees with defined benefit plans are as follows:

Funding - An employer must adequately fund defined-benefit plans. Employers typically employ the services of actuaries to calculate the required amount of funding to meet future projected pension payment demands.

Vesting - A pension plan must vest ownership in the employee within a specified time. That is, the employee becomes entitled to receive benefits under the pension plan after a specified period. The percentage or rate of benefit entitlement is calculated as a percentage of full benefits based on the period or length of employment.

Guarantee - Employees pay premiums to the Pension Benefit Guaranty Corporation to insure the defined benefit plan against loss.

Discussion Question

Why do you think the government heavily regulates retirement accounts or plans and the companies that sponsor them? What are some arguments against this form of regulation? Do you believe these provisions are sufficient to achieve the government objectives? Why or why not?

Practice Question

ABC Corp decides to offer a retirement plan for its employees. The plan provisions will apply equally to everyone in the company. Can you write a short memo explaining the difference between a defined benefit and defined contribution pension plan? Also, can you explain the primary requirements that the employer must ascertain to protect employee interests in the plan?

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employee retirement income security act erisa

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