A retirement plan is an employee benefit plan established or maintained by an employer or by an employee organization (such as a union), or both, that provides retirement income or defers income until termination of covered employment or beyond. A number of retirement plans are available, including the 401(k) plan and the traditional pension plan, known as a defined benefit plan.
Summary of requirements
Qualified plans. Qualified benefit plans offer tax-favored benefits to both employers and employees. To secure these favorable tax treatments, plans must comply with Title I of Employee Retirement Income Security Act (ERISA) and applicable provisions of the Internal Revenue Code. Two varieties of qualified plans exist: defined benefit plans, and defined contribution plans.
- A defined benefit plan promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service; for example, one percent of average salary for the last five years of employment for every year of service with an employer. The benefits in most traditional defined benefit plans are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation.
- A defined contribution plan, on the other hand, does not promise a specific amount of benefits at retirement. In these plans, the employee or the employer (or both) contribute to the employee’s individual account under the plan, sometimes at a set rate, such as five percent of earnings annually. These contributions generally are invested on the employee’s behalf. The employee will ultimately receive the balance in their account, which is based on contributions plus or minus investment gains or losses. The value of the account will fluctuate due to the changes in the value of the investments. Examples of defined contribution plans include 401(k) plans, employee stock ownership plans, and profit-sharing plans.
- Other types of qualified plans include as IRAs (individual retirement accounts), simplified employee pensions, 403(b) plans, Savings Incentive Match Plans for Employees (SIMPLE), and 457 plans. These are often used by the self-employed, employees of small companies, and tax-exempt organizations.
Nonqualified plans. Some companies provide additional benefits to executives via nonqualified deferred compensation plans. These plans either allow participants to defer receipt of income, or provide a supplemental retirement benefit beyond the limits placed on qualified plans. As such, the employee’s benefit is unsecured and not protected by ERISA or the Employee Benefit Security Administration.
Eligibility. ERISA establishes certain minimum eligibility requirements for retirement benefit plans, mandating that employees cannot be excluded from participating provided they are at least 21 years old and have completed one year of service.
Vesting. The act also establishes minimum vesting requirements for retirement benefit plans. Two different types of vesting exist:
- Cliff vesting is where benefits derived from employer contributions become 100 percent nonforfeitable after passage of a certain number of years.
- Graded vesting is where the benefits derived from employer contributions become incrementally nonforfeitable over a set period of years.
Summary plan descriptions. ERISA also requires that benefit plans describe how claims for benefits are to be administered and how appeals of adverse benefit claims determinations are to be handled. Benefit plan sponsors are required to provide their participants with written summaries of their rights, benefits, and responsibilities under their plans, designed to be easily understood by the reader. These summary plan descriptions must be issued once every five years, and if plans are changed in the interim years, sponsors must distribute, to the participants, summaries that describe the changes.
Retirement plan fee disclosures. The investment of plan assets is a fiduciary act governed by the fiduciary standards in ERISA section 404(a)(1)(A) and (B), which require plan fiduciaries to act prudently and solely in the interest of the plan’s participants and beneficiaries.
When a plan allocates investment responsibilities to participants or beneficiaries, the plan administrator must take steps to ensure that such participants and beneficiaries, on a regular and periodic basis, are made aware of their rights and responsibilities with respect to the investment of assets held in, or contributed to, their accounts. Participants and beneficiaries must also be provided sufficient information regarding the plan and the plan’s investment options, including fee and expense information, to make informed decisions with regard to the management of their individual accounts.
Plan administrators must provide to each participant or beneficiary certain plan-related information and certain investment-related information. These categories of information are described below.
Plan-Related Information. The first category of information that must be disclosed is plan-related information. This general category is further divided into three subcategories as follows:
- General Plan Information: General plan information consists of information about the structure and mechanics of the plan, such as an explanation of how to give investment instructions under the plan, a current list of the plan’s investment options, and a description of any “brokerage windows” or similar arrangement that enables the selection of investments beyond those designated by the plan.
- Administrative Expenses Information: This information includes an explanation of any fees and expenses for general plan administrative services that may be charged to or deducted from all individual accounts. Examples include fees and expenses for legal, accounting, and recordkeeping services.
- Individual Expenses Information: An explanation of any fees and expenses that may be charged to or deducted from the individual account of a specific participant or beneficiary based on the actions taken by that person. Examples include fees and expenses for plan loans and for processing qualified domestic relations orders. The information in these three subcategories must be given to participants on or before the date they can first direct their investments, and then again annually thereafter.
- Statements of Actual Charges or Deductions: In addition to the plan-related information that must be furnished upfront and annually, participants must receive statements, at least quarterly, showing the dollar amount of the plan-related fees and expenses (whether “administrative” or “individual”) actually charged to or deducted from their individual accounts, along with a description of the services for which the charge or deduction was made. These specific disclosures may be included in quarterly benefit statements required under section 105 of ERISA.
Investment-Related Information. The second category of information that must be disclosed is investment-related information. This category contains several subcategories of core information about each investment option under the plan, including:
- Performance Data: Participants must be provided specific information about historical investment performance. 1-, 5- and 10-year returns must be provided for investment options, such as mutual funds, that do not have fixed rates of return. For investment options that have a fixed or stated rate of return, the annual rate of return and the term of the investment must be disclosed.
- Benchmark Information: For investment options that do not have a fixed rate of return, the name and returns of an appropriate broad-based securities market index over 1-, 5-, and 10-year periods (matching the Performance Data periods) must be provided. Investment options with fixed rates of return are not subject to this requirement.
- Fee and Expense Information: For investment options that do not a have a fixed rate of return, the total annual operating expenses expressed as both a percentage of assets and as a dollar amount for each $1,000 invested, and any shareholder-type fees or restrictions on the participant’s ability to purchase or withdraw from the investment.
- For investment options that have a fixed rate of return, any shareholder-type fees or restrictions on the participant’s ability to purchase or withdraw from the investment.
- Internet Web Site Address: Investment-related information includes an Internet Web site address that is sufficiently specific to provide participants and beneficiaries access to specific additional information about the investment options for workers who want more or more current information.
- Glossary: Investment-related information includes a general glossary of terms to assist participants and beneficiaries in understanding the plan’s investment options, or an Internet Web site address that is sufficiently specific to provide access to such a glossary.
Comparative Format Requirement. Investment-related information must be furnished to participants or beneficiaries on or before the date they can first direct their investments, and then again annually thereafter. It also must be furnished in a chart or similar format designed to facilitate a comparison of each investment option available under the plan.
Miscellaneous.
- Plan administrators have some protection from liability for the completeness and accuracy of information provided to participants if the plan administrator reasonably and in good faith relies upon information provided by a service provider.
- After a participant has invested in a particular investment option, the participant must be provided any materials the plan receives regarding voting, tender, or similar rights in the option.
- Upon request, the plan administrator must also furnish prospectuses, financial reports, and statements of valuation and of assets held by an investment option.
- The general disclosure regulation at 29 CFR 2520.104b-1 applies to material furnished under this regulation, including the safe harbor for electronic disclosures at paragraph (c) of that regulation.
