To most business owners, the term “ERISA” may not be known, although it’s ABC to tax and benefits pros. ERISA has likely had an impact on you and your business. On September 2, 1974, the Employee Retirement Income Security Act (ERISA) was signed into law. It was enacted to provide protections for participants in privately-sponsored retirement plans. With amendments over the years, it’s the law that governs how businesses handle retirement plans and many other employee benefit plans. It’s interesting (at least to me and hopefully to you) to see what ERISA means for your business.
What changed
You have to know what things were like before 1974 to appreciate the importance of ERISA. According to BLS, retirement plans weren’t ubiquitous and those that existed often had requirements for benefits that weren’t easily met. BLS has these examples:
- Some plans required employees to work 2 years or more or reach 25 years of age or older prior to participating in the plan.
- Some plans lacked any vesting requirements; this means that if workers left the employer before retirement age, regardless of years of service, they received no benefits.
- Some plans required workers to reach 40 years of age or older and/or work 15 years or more before they were vested in their benefits.
- Some plans did not include benefits for a surviving spouse.
- Some plans required employees to work to age 65 and have at least 15 years of service to be eligible for “normal retirement” benefits.
- Some plans did not have an “early retirement” option (reduced benefits to account for receipt over a long period) or allowed employees to retire early only with the employer’s consent.
There were many retirement plan failures, leaving participants with nothing. For example, in 1963, Studebaker terminated its pension plan and left more than 4,000 workers without their promised retirement benefits. And there were numerous examples of people being fired just short of benefit eligibility. Then came ERISA…
Types of retirement plans. There were 2 main types of plans: pension plans (defined benefit plans) and profit-sharing plans (defined contribution plans). In 1975, 32% of all plans were pension plans and 68% were profit-sharing plans. ERISA made it possible for 401(k) plans, which are the most popular type of retirement plan today. Last year it was reported that only 15% of plans were pension plans.
Participation and vesting. ERISA set the rules for participation and vesting to ensure fairness. ERISA originally required that plan participation be available to those who reach age 25 with 1 year of service (although this was subsequently amended to age 21 with 1 year of service). ERISA originally required that participants become fully vested after 10 years (called “cliff vesting”) or partially vested after 5 years, increasing until full vesting is achieved after 15 years (called “graded vesting”); this was later changed to cliff vesting after 5 years and graded vesting from 3 to 7 years. Today, the same participation requirement applies, but in certain plans (e.g., safe harbor 401(k)s), there’s full vesting from day one or in year 2.
401(k) plans. Until ERISA, all retirement plans were funded solely with employer contributions. Cash or deferred arrangements (CODAs) arose through ERISA as the precursor of 401(k)s. (The name 401(k) is based on Subsection K of Section 401 of the Internal Revenue Code that governs the plan.) The Revenue Act of 1978 essentially ushered in the 401(k) plan we know today, with the first plan operational in 1980. The next year, when IRS regulations approved of wage deferral into 401(k)s, these plans started to become popular. Initially, there was no separate cap on salary deferrals; just an overall limit on employee and employer contributions. The salary deferral cap began in 1986, at $7,000. The limit in 2024 is $23,000, with an extra $7,500 for those age 50 and older by the end of the year.
IRAs. Until ERISA, there was no tax-favored retirement savings option for workers not covered by a company plan. ERISA changed this by creating IRAs. These accounts were meant not only to enable workers without access to a company-sponsored plan to save for retirement on a tax-advantaged basis, but also to be a vehicle for rolling over benefits from a company plan when a worker left the job. The first annual contribution limit was set at $1,500, but no more than 15% of earnings. In 2024, it is 100% of earnings up to a $7,000 maximum contribution, with an additional $1,000 for those age 50 and older by the end of the year. It didn’t start to be adjusted annually for inflation until 2001; before then there was only one increase in 1982 to $2,000.
PBGC. The Studebaker pension failure mentioned earlier is just one example of companies that didn’t live up to their promises to workers. ERISA created a type of government insurance plan—PBGC—for workers covered participating in pension plans. If the plan goes under or is underfunded (there aren’t sufficient assets in the plan to pay the promised pensions), workers are assured of at least some monthly pension amount.
Final thought
Today, ERISA may be viewed by some as a law that only added to paperwork and complications of employers trying to provide an important benefit to their staff. No doubt, this is true, with various required disclosures to participants and annual filing with the government. But there are a growing number of tax breaks for employers to encourage offering a plan as well as helpful protections to participants who want a secure retirement future.
For more information concerning retirement plan changes see blogs here.
On a side note: Those who know me know I’ve been into the subject of taxes for a long time. When my first daughter was born in 1977, Erica was the “hot” girl’s name starting with the letter “E.” I needed a name starting with the letter E and had wanted to name her Erisa. Her father rejected the idea, so we chose Emily.
