ERISA Issues

ERISA Issues

The Employee Retirement Income Security Act (ERISA), enacted in 1974, governs private-sector employer-sponsored retirement plans and (with modifications) health and welfare plans. The Series 66 tests working command of ERISA fiduciary standards, prohibited transactions, eligibility and vesting rules, distribution rules including spousal protections, reporting and disclosure requirements, fidelity bond rules, and the boundaries of what ERISA covers (governmental, church, and top-hat plans are exempt). Five sections: framework and fiduciary duties; prohibited transactions and party-in-interest; eligibility, vesting, and distribution rules; reporting, disclosure, fidelity bonds, and QDIAs; and ERISA boundaries including QDROs. One interactive: a vesting schedule comparison that visualizes how 3-year cliff and 6-year graded schedules differ at any point in an employee's tenure.

ERISA — what it covers and what it doesn't

Enacted September 2, 1974, the Employee Retirement Income Security Act was Congress's response to widely-publicized pension failures (Studebaker 1963 is the canonical example). ERISA established federal minimum standards for most PRIVATE-SECTOR employer-sponsored retirement plans and certain health and welfare plans.

What ERISA covers: private-sector employer-sponsored qualified retirement plans (401(k), 403(b), defined benefit pensions, profit-sharing, ESOPs); group health plans; some welfare benefit plans. Administered jointly by the DEPARTMENT OF LABOR (DOL, fiduciary and reporting), the IRS (tax qualification), and the PBGC (defined benefit pension insurance).

What ERISA does NOT cover (key Series 66 exam points):

• Governmental plans (federal, state, local government employee plans). Exempt because they have their own statutory frameworks.
• Church plans (unless they elect ERISA coverage).
• Top hat plans — nonqualified deferred compensation for a select group of management or highly compensated employees. Limited ERISA reporting only.
• IRAs (Traditional, Roth, SEP, SIMPLE). NOT employer-sponsored ERISA plans, though SEP and SIMPLE involve employer activity. Individual IRAs have separate IRC protections.
• Plans covering only a sole proprietor or partners with no other employees (Solo 401(k) when truly solo).

Title I of ERISA contains the fiduciary and reporting rules tested on the Series 66.

Who is a fiduciary under ERISA?

ERISA defines fiduciary status FUNCTIONALLY — based on what a person DOES, not what their title is. Two paths to fiduciary status:

• NAMED FIDUCIARY. Specifically identified in the plan document. Usually includes the plan administrator (often the employer), the trustee, and (where applicable) the investment manager. Named fiduciaries always have fiduciary responsibility.
• FUNCTIONAL FIDUCIARY. Any person who: (a) exercises DISCRETIONARY AUTHORITY over plan management or administration; (b) exercises DISCRETIONARY AUTHORITY over plan assets; OR (c) provides INVESTMENT ADVICE for a fee. The functional test means a service provider may become a fiduciary regardless of contractual disclaimers.

Investment-advice fiduciaries. The 2024 DOL Retirement Security Rule (the “new fiduciary rule”) expanded fiduciary status to include one-time recommendations to roll over from a 401(k) to an IRA — provided the recommendation meets a regular-basis-or-mutual-understanding test. This shifted the boundary on rollover recommendations significantly.

Once someone is a fiduciary, ERISA fiduciary duties (next block) apply. Personal liability for fiduciary breaches can be severe — ERISA permits suit for losses to the plan plus profits earned from breach, with co-fiduciary liability for failures to monitor.

The four core fiduciary duties

ERISA section 404(a) imposes four primary duties on plan fiduciaries:

1. Duty of LOYALTY (exclusive benefit rule). Act solely in the interest of plan participants and beneficiaries, for the exclusive purpose of providing benefits and defraying reasonable plan expenses. Fiduciary's own interests (and the EMPLOYER's interests) are subordinate to participants' interests. The most-tested duty.
2. Duty of PRUDENCE (prudent expert standard). Act with the care, skill, prudence, and diligence that a PRUDENT PERSON FAMILIAR WITH SUCH MATTERS would use in similar circumstances. Higher than the ordinary prudent-person standard — ignorance of investments is not a defense; if the fiduciary lacks expertise, they must hire experts.
3. Duty to DIVERSIFY. Diversify plan investments to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so. ERISA does not require any specific number of investments; the standard is about avoiding undue concentration.
4. Duty to FOLLOW THE PLAN DOCUMENT. Act in accordance with the documents and instruments governing the plan, except where the plan document conflicts with ERISA (in which case ERISA controls).

Breach of these duties exposes the fiduciary to personal liability for plan losses and any profits earned by the fiduciary through use of plan assets. ERISA Section 411 also imposes specific PROHIBITED-PARTY rules and Section 502 provides civil enforcement (covered next section).

Prohibited transactions and party-in-interest

ERISA Section 406 absolutely prohibits certain transactions between a plan and a PARTY IN INTEREST, regardless of whether the transaction is fair or beneficial to the plan. The prohibition exists because of the temptation for self-dealing, not because every prohibited transaction actually harms the plan.

Who is a party in interest?

• Plan fiduciaries (named or functional)
• Persons providing services to the plan (recordkeepers, custodians, consultants)
• The employer sponsoring the plan and its 50%+ owners, officers, directors, highly compensated employees
• Relatives of the above (spouse, ancestor, descendant, or spouse of descendant)
• Entities 50%+ owned by parties in interest

Per se prohibited transactions between plan and party in interest:

• Sale, exchange, or lease of property
• Lending money or extending credit (subject to participant-loan exemption discussed below)
• Furnishing of goods or services
• Transfer of plan assets to or use by a party in interest
• Acquiring or holding employer securities or employer real property in excess of statutory limits (10% for most plans)

Self-dealing prohibitions (separately under ERISA 406(b)) apply specifically to fiduciaries: a fiduciary cannot deal with plan assets in their own interest, act on both sides of a transaction adverse to the plan, or receive consideration for transactions involving plan assets.

Statutory exemptions to the prohibited-transaction rules

Several common transactions WOULD be prohibited but for specific statutory exemptions. The most-tested:

• Participant loans (ERISA 408(b)(1)). Loans from a qualified plan to a participant are permitted if: (a) loans are available on a reasonably equivalent basis to all participants; (b) the loan bears a REASONABLE INTEREST RATE; (c) the loan is adequately secured; (d) the loan does not exceed the lesser of $50,000 or 50% of vested balance; (e) repayment within 5 years (longer for primary residence purchase).
• Plan service contracts (ERISA 408(b)(2)). Plans may contract with parties in interest for plan services if the services are necessary, the arrangement is reasonable, and no more than reasonable compensation is paid.
• QPAM exemption. A Qualified Professional Asset Manager (QPAM) — a registered investment adviser meeting size/independence thresholds — can engage in transactions with parties in interest under DOL prohibited transaction exemption rules.
• Employer securities and real property (ERISA 407). Plans may hold up to 10% of plan assets in qualifying employer securities or real property (more for ESOPs, which are designed around employer-securities concentration).

Penalties for prohibited transactions. A 15% excise tax on the amount involved (IRC 4975), per year until corrected. If not timely corrected, a SECOND-TIER tax of 100% applies. Personal liability for restoring losses plus disgorging profits also applies under ERISA Section 502.

ERISA eligibility rules — the 21+1 standard

ERISA Section 202 sets MAXIMUM eligibility requirements that an employer can impose for participation in a qualified plan. The employer CAN be more generous; cannot be more restrictive.

• Standard: Employee must be eligible after reaching age 21 AND completing 1 year of service (1,000 hours in 12 consecutive months).
• The 2-year/100%-vested alternative: Employer can require up to 2 years of service if the plan provides 100% IMMEDIATE VESTING for employer contributions. The 2-year service requirement is permitted only when paired with full immediate vesting.
• SECURE Act long-term part-time worker rule. Long-term part-time workers (500+ hours per year for 3 consecutive years, reduced to 2 years under SECURE 2.0 for plan years beginning 2025) must be permitted to make elective deferrals to a 401(k) plan even without meeting the 1,000-hour rule.
• Entry dates. After meeting the eligibility threshold, the employee must enter the plan no later than the earlier of: (a) the first day of the first plan year beginning after the eligibility date; or (b) 6 months after the eligibility date. Most plans use SEMI-ANNUAL entry dates (January 1 and July 1).

The 21+1 standard is the BASELINE most-tested eligibility requirement. Note that age 21 is a CEILING — the plan can permit younger participants if the employer chooses.

Vesting schedules — 3-year cliff and 6-year graded

EMPLOYEE contributions (own salary deferrals) are ALWAYS 100% vested immediately — ERISA does not permit any forfeiture of employee-funded amounts. EMPLOYER contributions (matches, profit-sharing) are subject to vesting schedules.

For employer matching contributions to qualified plans (post-Pension Protection Act 2006), ERISA permits two MAXIMUM vesting schedules:

Employer flexibility: these are CEILINGS — the employer can vest faster (including immediate). For SIMPLE IRAs and SEPs, ERISA requires 100% immediate vesting (no schedules permitted). For top-heavy plans (where key employees hold >60% of plan assets), accelerated vesting schedules apply (currently 2-year cliff or 3-year graded).

QPSA and QJSA — ERISA spousal protections

ERISA requires DEFINED BENEFIT plans and certain DEFINED CONTRIBUTION plans (money purchase pensions, target benefit) to provide spousal-protection annuities. Most 401(k) profit-sharing plans are NOT subject to these requirements (they generally pay out as lump sums to the named beneficiary), but some plans elect to provide these protections.

• Qualified Joint and Survivor Annuity (QJSA). The default form of payment for a MARRIED participant. Pays the participant during life; upon participant's death, continues paying a surviving spouse at 50%-100% of the participant's amount (specific percentage depends on plan). Both spouses must CONSENT IN WRITING (notarized or witnessed by plan rep) to waive QJSA and elect another form of payment.
• Qualified Pre-Retirement Survivor Annuity (QPSA). If a vested married participant dies BEFORE beginning benefits, the surviving spouse receives a lifetime annuity. The plan funds the QPSA automatically; spousal consent is required to WAIVE this protection.
• Spousal consent requirements. To waive either protection, the spouse must consent in writing, the consent must be witnessed by a plan representative or notary, and the consent must specifically identify the beneficiary or form of payment being elected.

Why this matters on the exam: a participant who tries to designate someone other than their spouse as primary beneficiary of an ERISA pension — without proper spousal consent — will find the designation invalid. The spouse always takes precedence under QJSA/QPSA unless they affirmatively waived rights through a notarized writing.

Reporting and disclosure — Form 5500, SPD, SAR

ERISA imposes specific reporting requirements on plans and disclosure requirements to participants. Failing these creates per-day penalties (often hundreds of dollars per day) and DOL audit exposure.

• Form 5500 (Annual Report). Filed annually with the DOL/IRS reporting plan financial activity, participant counts, and plan operations. Different schedules apply depending on plan size and type. Public document — available via EFAST2 search. Small plans (under 100 participants) may file the simpler Form 5500-SF.
• Summary Plan Description (SPD). The PRINCIPAL written participant disclosure. Plain-language summary of plan terms, eligibility, vesting, contribution and distribution rules, claims procedure, and participant rights. Required to be provided to participants within 90 days of becoming a participant and updated every 5 years (10 years if no amendments).
• Summary of Material Modifications (SMM). When the plan is amended in a way that materially affects information disclosed in the SPD, an SMM must be distributed within specific timeframes.
• Summary Annual Report (SAR). A brief annual narrative summary of the Form 5500 financials. Distributed to participants within 9 months after the plan year end (or earlier if Form 5500 is filed earlier).
• Participant fee disclosure (404a-5). For participant-directed plans, annual disclosure of plan-level fees and per-investment fee/return information. Must be provided at enrollment and annually thereafter.
• Benefit statements. Quarterly for participant-directed plans; annually for other DC plans; every 3 years for DB plans (or annually upon request).

Fidelity bonds — the 10% rule

ERISA Section 412 requires every person who HANDLES PLAN FUNDS or other property to be covered by a FIDELITY BOND. The bond protects the plan against losses from fraud or dishonesty by the person handling plan funds. Specific testable points:

• Bond amount: 10% of plan assets that the person handles. Calculated based on plan assets at the beginning of the plan year.
• Minimum bond: $1,000. Even very small plans require this baseline.
• Maximum bond: $500,000 in the standard case. The 10% calculation is capped at $500,000 per plan.
• Maximum bond with employer securities: $1,000,000. Plans holding EMPLOYER SECURITIES require a doubled maximum bond of $1 million (the increased cap recognizes the elevated risk profile of self-dealing in employer-securities transactions).
• Coverage required for everyone handling plan funds — trustees, officers, employees of the plan administrator, third-party administrators. The bond is on the PERSON, not the entity.

Common exam framing: a plan with $5 million in assets, no employer securities, requires a $500,000 fidelity bond (10% of $5M = $500K, equal to the cap). The same plan with employer securities holding requires a $500,000 bond — same calculation but with a $1M maximum that hasn't been triggered. A plan with $20 million in assets and employer securities requires $1,000,000 (10% of $20M = $2M, capped at $1M).

QDIAs — the four permitted types

A QUALIFIED DEFAULT INVESTMENT ALTERNATIVE (QDIA) is the default investment vehicle used when a participant in a self-directed plan FAILS TO MAKE AN INVESTMENT ELECTION. Properly selecting a QDIA gives the plan sponsor SAFE HARBOR PROTECTION under ERISA 404(c)(5) — the sponsor isn't liable for participant losses from the default placement.

DOL regulations identify FOUR types of QDIAs:

1. TARGET-DATE FUND (TDF). Asset allocation that becomes more conservative as the target date (assumed retirement) approaches. The dominant QDIA type in practice — used by >90% of plans.
2. BALANCED FUND. A single fund with a mix of equity and fixed income consistent with the demographics of the plan as a whole.
3. MANAGED ACCOUNT. A service that allocates the participant's account among the plan's investment options based on the participant's individual circumstances (age, balance, savings rate).
4. SHORT-TERM CAPITAL-PRESERVATION VEHICLE. Money market or stable-value fund — permitted as a QDIA only for the first 120 DAYS after a participant's first contribution. After 120 days, must transition to one of the other three types.

The QDIA safe harbor requires: (a) the plan satisfies 404(c) safe harbor requirements generally; (b) the QDIA is one of the four permitted types; (c) participants receive ADVANCE NOTICE (typically 30 days before the first contribution or 30 days before reallocation); (d) participants can transfer out without penalty during specified windows; (e) the QDIA is managed by an investment manager or registered mutual fund. Notably, the safe harbor protects the sponsor from liability for the OUTCOMES of the default investment — not from the obligation to PRUDENTLY SELECT AND MONITOR the QDIA itself.

ERISA-exempt plans — what falls outside the scope

Not all retirement plans are subject to ERISA. Several categories are exempt either in full or in part:

• Governmental plans. Plans for federal, state, or local government employees. Exempt because they have their own statutory frameworks (e.g., FERS for federal civilian, state pension systems). Includes 457(b) governmental plans, state university 403(b) plans, etc.
• Church plans. Plans maintained by a church or convention of churches for its employees. Default-exempt but can ELECT ERISA coverage. The church-plan exemption has been the subject of significant litigation around what counts as a “church-affiliated” organization.
• Top hat plans. Nonqualified deferred compensation plans maintained for a SELECT GROUP OF MANAGEMENT OR HIGHLY COMPENSATED EMPLOYEES. Exempt from ERISA Title I's participation, vesting, funding, and fiduciary requirements. Subject only to ERISA reporting and disclosure (limited — usually a one-time top-hat statement filing). Operate under IRC 409A.
• Plans covering only sole proprietors or partners with no employees. Solo 401(k) plans without rank-and-file employees are not subject to ERISA Title I.
• Foreign plans. Plans covering primarily nonresident aliens working outside the US.
• Excess benefit plans. Plans designed solely to provide benefits in excess of the IRC contribution and benefit limits, for any employee.

The most-tested exam point: governmental plans and top-hat plans are not ERISA Title I plans, meaning the fiduciary, vesting, and most reporting rules don't apply — though IRC tax-qualification rules and some employment-law rules still do.

QDROs — the divorce-and-retirement intersection

A QUALIFIED DOMESTIC RELATIONS ORDER (QDRO) is a state court order (typically in a divorce, child support, or separation context) that creates or assigns a right to receive a portion of a retirement plan participant's benefits to an ALTERNATE PAYEE (spouse, former spouse, child, or other dependent). QDROs are the ONLY mechanism by which an ERISA plan participant's benefits can be paid to someone other than the participant (or their designated beneficiary), bypassing ERISA's anti-alienation provisions.

• Plan administrator must determine qualification. Upon receipt of a draft DRO, the plan administrator reviews whether the order meets ERISA's QDRO requirements. If it does, the order becomes a “qualified” DRO and the plan must comply.
• QDRO requirements. Must clearly specify: (a) the name and last known mailing address of the participant and alternate payee; (b) the amount or percentage of the participant's benefits to be paid; (c) the number of payments or period for which the order applies; (d) the plan to which the order applies. Cannot require the plan to provide a type or form of benefit not otherwise available.
• Anti-alienation otherwise. ERISA Section 206(d) generally prohibits assignment or alienation of plan benefits. QDROs are the principal exception. Other exceptions include voluntary participant elections (subject to limits) and federal tax levies.
• Tax treatment. For QDROs, the alternate payee is taxed as if they were the participant on distributions received. Critically, if the alternate payee receives a distribution directly (not rolled over), the 10% early-withdrawal penalty does NOT apply — making QDRO distributions a unique exception to the 10% penalty rules.

ERISA fiduciary standards — baseline summary

The Employee Retirement Income Security Act (ERISA) sets standards for employer-sponsored retirement plans. Key fiduciary issues tested on the Series 66 include:

Qualified Default Investment Alternatives (QDIAs). When plan participants don't make an investment selection, employers can default contributions into a QDIA (such as a target-date fund) and receive fiduciary safe harbor protection under ERISA. The safe harbor protects the sponsor from liability for the OUTCOMES of the default investment — but not from the obligation to prudently select and monitor the QDIA. Four QDIA types are permitted: target-date fund, balanced fund, managed account, and short-term capital-preservation vehicle (limited to 120 days).

Prudent expert standard. ERISA requires fiduciaries to act with the care, skill, prudence, and diligence of a person FAMILIAR WITH such matters — higher than the ordinary prudent-person standard. Lack of expertise is not a defense; the fiduciary must hire experts when needed.

Diversification requirement. Fiduciaries must diversify plan investments to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so.

ERISA fiduciary duties — complete framework

Plan fiduciaries must follow four core duties under ERISA:

• Duty of loyalty. Act SOLELY in the interest of plan participants and beneficiaries — their interests come before the fiduciary's own interests or the employer's interests.
• Prudent expert standard. Act with the care, skill, prudence, and diligence of a prudent person FAMILIAR WITH SUCH MATTERS. Higher than ordinary prudence; expertise is required (or must be hired).
• Diversification. Diversify plan investments to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so.
• Adherence to plan documents. Act in accordance with the documents and instruments governing the plan, except where they conflict with ERISA (ERISA controls).

Co-fiduciary liability applies when one fiduciary knowingly participates in another's breach or fails to remedy a breach when aware of it. Personal liability for plan losses and disgorgement of profits earned through breach can be severe.

Section 404(c) safe harbor — participant-directed plans

ERISA Section 404(c) provides a safe harbor for plan fiduciaries in participant-directed plans. If the plan meets these conditions, fiduciaries are not liable for losses resulting from participants' own investment choices:

• Plan offers at least 3 diversified investment options with materially different risk/return characteristics
• Participants receive sufficient information to make informed decisions (prospectuses, fee disclosures, performance history)
• Participants can give investment instructions at least quarterly (most plans permit daily reallocation)
• Participants have the opportunity to obtain written confirmations of their instructions
• Plan provides ongoing fee and performance information (404a-5 disclosures)

The 404(c) safe harbor protects the plan sponsor from liability for LOSSES RESULTING FROM PARTICIPANT INVESTMENT CHOICES. It does NOT protect the sponsor from liability for: (a) prudent SELECTION and MONITORING of the investment menu offered; (b) reasonableness of plan fees and expenses; (c) compliance with other ERISA fiduciary duties. The investment-menu construction itself remains a fiduciary act subject to all four core duties.