How far have we come since 1974? The Employee Retirement Income Security Act (ERISA) was adopted 50 years ago to reform the U.S. pension system. ERISA established national standards for benefit security. The anniversary of its passage in 1974 is an appropriate time to evaluate the progress that has been made over the years in expanding and enhancing participant protections. It is also a good time to assess where ERISA has fallen short. While any such evaluation is necessarily subjective, here is the perspective of someone who has been practicing in this area since shortly after the passage of ERISA.
Pension Failures Were the Catalyst for Reform.
Few people today recall the failure of auto maker Studebaker and the resultant loss of pensions by its workers. Before ERISA, employers could adopt plans in which short breaks in service resulted in a loss of accumulated vesting credits and forced the participant to start over. Plans were required to fully vest participants only at normal retirement age or on plan termination, though some plans did have earlier vesting schedules. Benefits were vested only to the extent funded, and funding rules were lenient. Some Studebaker employees ended up receiving only about 15% of their vested benefits when the pension plan terminated. The failure of Studebaker (and some others) was a catalyst that sparked interest in legislation to make sure that such losses of pensions earned over many years of service wouldn’t recur.
Major ERISA Reforms
New Vesting and Accrual Requirements-Benefits attributable to employer contributions were required to vest during employment under minimum vesting schedules. These schedules were substantially shortened by amendments over time to provide a choice between 3 year cliff vesting and gradual vesting over 6 years. Backloading was prohibited. This means that benefits would be earned at least ratably over the period of employment and could not be earned mostly in the years preceding retirement. ERISA also established rules determining when pre-break service had to be recognized by plans.
New Fiduciary Responsibilities-ERISA imposed nationwide fiduciary responsibilities on the persons managing plan administration and plan investments based on the common law of trusts. Fiduciaries could be personally liable for losses caused by breaches of fiduciary responsibilities, such as the duties of prudence and loyalty. Transactions with related parties and self-dealing by fiduciaries were prohibited unless specifically exempted.
A National Pension Insurance Program- Most single employer defined benefit plans were covered by a federal pension insurance program funded by plan sponsor premiums and administered by the Pension Benefit Guaranty Corporation (PBGC). Participants became entitled to guaranteed benefits if their employer became bankrupt or insolvent.
ERISA was fine-tuned and amended during the succeeding years to incorporate many positive changes.
Ending Gender and Age-Based Discrimination-When ERISA was enacted, plans had different retirement ages for men and women, and women were required to pay more to fund the same dollar pension as a similarly-situated man because they had a longer life expectancy under the actuarial tables. After a U.S. Supreme Court decision called Manhart, 435 U.S. 702 (1978), these gender-based distinctions were eliminated. Mandatory retirement based on age was also legal, and employees who did work after normal retirement age did not have a right to continue to earn benefits during that time. The law was changed in 1986 to prohibit employers from forcing most employees to retire at a fixed age and to require those still working to receive post-normal retirement age accruals.. The Older Workers’ Benefit Protection Act required employers to provide either equal benefits or to expend the same costs for older workers as for younger workers in providing other types of benefits.
Spousal Protections- The Retirement Equity Act (REA) prevented loss of prior vesting service due to taking maternity or paternity leave or for breaks in service shorter than 5 years, required written spousal consent in order for a married participant to elect a benefit other than the qualified joint and survivor annuity, such as a lump sum, and required spousal death benefits for terminated vested participants not in pay status. Although ERISA had required plans to make a joint and survivor annuity with the participant’s spouse the standard form of payment for married participants, prior to REA the spouse’s written consent was not required to waive it.
REA also recognized qualified domestic relations orders (QDROs) splitting benefits between spouses in the event of divorce or for child support. The law was also changed to permit QDROs to provide for an immediate lump sum payment to the non-participating spouse. We take QDROs for granted now, but before the law was changed, there were questions whether these state court orders were preempted by ERISA and the IRS had questioned whether they violated a rule against assigning benefits and whether they could permit payment before the earliest time the participant was entitled to get paid. This could be years after the order was submitted.
The Multiemployer Pension Plan Amendments Act-ERISA didn’t address these plans covering workers in the same union, though it was known that they were underfunded, jeopardizing pensions for the covered workers. MEPPAA provided that a portion of the plan’s underfunding would be assessed against any employer withdrawing from the plan so that remaining employers did not have the sole burden of funding these benefits. MEPPAA helped but didn’t provide a fix for underfunding. Multiemployer plans remain underfunded and efforts to shore up their funding, including a financial aid program for struggling plans, continue.
The Decline of Defined Benefit Plans -When ERISA was enacted most employers had defined benefit pension plans managed by the employer. These plans promised a fixed benefit reflecting pay and years of service, though many required employee contributions. Over the years, these plans were subject to stricter and faster funding rules and higher PBGC premiums, and punitive taxes were introduced on plan surpluses returned to the employer at termination. All of this led to many existing plans being frozen or terminated, and provided a disincentive to adopt new defined benefit plans.
401(k) Plans Dominate the Field -401(k) plans became the dominant form of retirement plan, and participant benefits reflected investment performance of their accounts as well as their own and any employer contributions. Self-directed plans under which participants were responsible for their own investment decisions predominate, though in recent years more plans are relying on professional investment management, managed accounts and other options in which professionals can take over investment responsibility. A new type of pooled 401(k) plan called a PEP allows unrelated employers to provide benefits under a plan that is managed by a fiduciary called a pooled plan provider, subject to limited fiduciary responsibilities of their own.
Fiduciary Breach Litigation Explodes- New class action lawsuits began to be filed challenging plan fees and investments as imprudent. These undoubtedly helped to reduce average plan fees, but they also have targeted plan fiduciaries who have made appropriate choices, even though in its Hughes decision, 142 S. Ct. 737 (2022), the Supreme Court recognized that there is no one right way to invest. New types of litigation also target defined benefit plan actuarial factors, welfare plans and insurance buyouts in which liabilities are transferred from defined benefit plans to insurance companies as well as the use of 401(k) plan forfeitures. The negative side of these lawsuits is that they can discourage qualified individuals from serving as fiduciaries and are flooding the courts.
Some think ERISA litigation has gotten out of control. We are waiting for the Supreme Court to accept a case that will clarify whether plan sponsors may avoid litigation by requiring mandatory arbitration of fiduciary breach claims.
Finally-Attention to Health Plans and other Welfare Benefits-ERISA covers welfare benefit plans such as medical, group life and disability plans. But the drafters of ERISA didn’t focus on them. We now have many layers of regulation applying to group health plans, and, courtesy of the Affordable Care Act (ACA), the right to obtain medical coverage in the group marketplaces and to obtain coverage regardless of pre-existing conditions. ACA also requires large employers to provide minimum essential coverage or pay a penalty.
Expanded 401(k) Coverage
Automatic enrollment has increased plan participation by requiring employees to opt out, not into participation. Beginning in 2025, new plans are required to have automatic enrollment. Plans must also now allow long-term part-time employees to make contributions, and can no longer exclude them because they do not complete 1000 hours of service.
Tax Incentives
Tax credits are available to qualifying employees who contribute to plans, as well as to employers adopting new plans.
Where ERISA Fell Short
Here are three top areas where ERISA has fallen short.
Too Many Uncovered Employees. Many employees are still not covered by employer-sponsored plans, particularly if they work for smaller businesses, and those who are covered aren’t saving enough. This gap particularly affects women and minorities, but the nation as a whole is not putting away enough money to fund a comfortable retirement. This gap in coverage may be the primary challenge facing employers, employees and Congress today. Many employers who don’t sponsor plans are afraid of fiduciary responsibility and complicated compliance rules, and studies show employers are often unaware of the tax incentives for adopting plans.
A relatively new factor in this equation is the advent of state retirement savings programs, which have been adopted by an increasing number of states to require employers who don’t sponsor their own plans to pass on employee contributions to IRAs. These have allowed employees to put some money away for retirement but can’t accept employer contributions. Recent studies show that they have not deterred new plan formation. This may be because pension plans can provide much larger benefits than the IRAs in the state programs. Proposals have been made to provide federalized alternatives, but that would be a major change from the private employer system and would face an uphill battle in Congress.
The Multiemployer Plan Challenge. Multiemployer pension plans have defied multiple efforts to shore up their funding, and further changes to the law governing them will undoubtedly be required.
The Loss of Defined Benefit Plans. The valuable right to earn a guaranteed lifetime pension was lost when so many defined benefit plans were terminated.as a result of ERISA requirements. Efforts are now being made to provide lifetime income options through 401(k) plans, but many still do not offer annuities. This could be made a legal requirement, as could making professional investment management available to 401(k) plan participants. On a parallel track, while no one expects a wholesale revival of defined benefit plans, they could be made more attractive by changes in the law. Plan sponsors want more certainty and less fluctuation in contributions and better treatment of plan surpluses.
All this is to say that ERISA is still a work in progress, and new ideas for providing more benefits to more employees are still needed.