1975, September, Pg. 1725. The Pension Reform Act of 1974: Vesting.

• Author: by R. Michael Sanchez

4 Colo.Law. 1725

Colorado Lawyer

1975.

1975, September, Pg. 1725.

The Pension Reform Act of 1974: Vesting

1725Vol. 4, No. 9, Pg. 1725The Pension Reform Act of 1974: Vestingby R. Michael Sanchez and James F. Wood, and Douglas M. CainThe Employee Retirement Income Security Act of 1974 (the Act) changes many of the old vesting requirements for employee benefit plans and adds several new ones. A substantial number of the vesting provisions, including the provisions governing applicability, penalties for noncompliance, service definitions, and break-in-service rules, are quite similar to the Act's participation provisions. The most apparent change wrought by the Act is the codification of three definite vesting schedules. Plans covered by either the Tax or Labor Titles of the Act must meet the requirements of one of the three vesting schedules. For reasons to be discussed, however, these vesting schedules may not deserve the attention which has been given to them. The Act also severely restricts the occasions on which a plan may exact forfeitures of an employee's benefits.

APPLICABILITY OF TAX AND LABOR TITLES AND PENALTIES FOR VIOLATION

Both the Tax and Labor Titles of the Act impose vesting requirements on plans.(fn1) The statutory framework for the vesting requirements is quite similar to the framework for the Act's participation requirements.(fn2) As with the participation requirements, there are differences in the types of plans to which the two titles apply and in their penalties for noncompliance.

With a few exceptions, the tax provisions apply to all pension, profit-sharing and stock bonus plans, and require compliance with the vesting rules as a condition for qualification.(fn3) The vesting rules do not apply to governmental plans,(fn4) church plans,(fn5) plans established by certain fraternal orders and societies,(fn6) and plans which have not provided for employer contributions at any time after September 2, 1974 (the Act's date of enactment).(fn7) To avoid application of the Act, these excepted plans must continue to meet the requirements of I.R.C. §§ 401(a)(4) (antidiscrimination rules) and 401(a)(7) (100 percent vesting upon termination) as those sections were written and interpreted prior to the Act.(fn8) In short, a plan not subject to the Act's vesting requirements remains subject to the old vesting rules. No civil or criminal sanctions attach to violations of the Tax Title's vesting rules.

The applicability of the vesting requirements of the Labor Title is determined by the same provisions which govern the applicability of the Labor Title's participation requirements.(fn9) Any plan, whether qualified or unqualified, is subject to the vesting requirements of the Labor Title unless specifically excepted. Although the Act provides a long list of exceptions,(fn10) most retirement plans will be subject to the vesting requirements.

The same remedies which apply to violations of the Labor Title's participation requirements also apply to violations of the vesting requirements.(fn11) While the Act does not provide for criminal liability or pre-set

1726civil penalties, the general enforcement provisions of Act § 502 permit participants, beneficiaries, fiduciaries, and the Secretary of Labor to obtain various forms of relief.(fn12) The breadth of § 502 quite conceivably could permit the imposition of civil liability on a plan or a fiduciary for losses to participants occasioned by the plan's failure to comply with the vesting requirements. For example, if a participant under the plan were 50 percent vested in $10,000 but under the Act should have been at least 75 percent vested, then conceivably the participant could sue to recover $2,500. If a plan's sponsor or fiduciary caused the plan to forfeit its qualified status, there could be liability for the consequences of the disqualification. In addition, a plan which fails to meet the Labor Title's vesting requirements is subject to suit for enforcement of the title's requirements and to injunctions for failure to comply with the Labor Title.(fn13)

In sum, the violation of the tax provisions will result in disqualification, and, whether a plan is qualified or unqualified, the violation of the labor provisions both invites litigation and exposes the plan fiduciaries to potential liability for damages.

MINIMUM VESTING STANDARDS

Full Vesting for Employee Contributions

Any qualified plan and any plan covered by the Labor Title must provide that an employee is fully vested at all times in the portion of his accrued benefit derived from his own contributions.(fn14)

For defined contribution plans, calculating the portion of the employee's accrued benefit derived from his own contributions is relatively easy. If the plan provides for separate accounts for employer and employee contributions, then the income, expenses, gains, and losses of the respective accounts are added or subtracted according to the market experience and administrative costs of the respective contribution accounts.(fn15) If employee and employer contributions are commingled, then the calculation is based on the ratio of the employee's own contributions to the total contributions made by the employer and the employee, taking into account any withdrawals attributable to either employee or employer contributions.(fn16)

For defined benefit plans, the calculation of the employee's accrued benefit derived from his own contributions is complex. Thus, some difficulty may arise in determining which portion of an employee's accrued benefit is subject to the rule that all benefits derived from an employee's own contributions are to be fully vested. If a defined benefit plan provides a benefit in the form of a single life annuity (without ancillary benefits) commencing payments at normal retirement age, the calculation involves the use of a market experience assumption ("accumulated contributions") and an actuarial assumption ("appropriate conversion factor").(fn17) An employee's accumulated contributions equal the sum of his mandatory contributions,(fn18) interest at the rate called for by the plan up to the date the Act's vesting requirements become effective for the plan, and then 5 percent interest compounded annually on the sum of the mandatory contributions and prior interest.(fn19) To calculate the employee's accrued benefit derived from his own contributions, the employee's accumulated contributions figure is multiplied by the "appropriate conversion factor,"(fn20) which is the factor necessary to convert an amount equal to the accumulated contributions to a single life annuity commencing at normal retirement age. This factor is set at 10 percent for a person 65 years old and will be set for other ages by the Secretary of the Treasury, according to guidelines established in the Act.(fn21) As an example of how the conversion factor is applied to an employee's accumulated contributions, an employee with $100,000 in accumulated contributions at age 65 would have to be deemed to have an accrued interest in the amount which it would take to purchase a single life annuity for him with $10,000 yearly payments (10 percent of $100,000).

For a defined benefit plan, the calculataion

17271728of the employee's accrued benefit derived from employee contributions apparently does not take into account optional employee contributions.(fn22) The treatment of optional versus mandatory employee contributions may illustrate a difference between the terms "vesting" and "accrued benefit." The difference between the terms has caused substantial confusion because, like the Mad Hatter,(fn23) the Act uses the terms interchangeably in some places and disparately in others.(fn24) In this instance optional and mandatory employee contributions are fully vested pursuant to I.R.C. § 411(a)(1). In contrast, only the mandatory (but not the optional) employee contributions are used to compute the accrued benefit of the employee.

Full Vesting Upon Attainment of Normal Retirement AgeAll plans covered by the Labor Title and all qualified plans must provide that an employee who attains "normal retirement age" be fully vested in his "normal retirement benefit."(fn25) The requirement of full vesting upon retirement applies regardless of where an employee otherwise might be situated on the plan's vesting schedule.

The terms "normal retirement age" and "normal retirement benefit" both have definitions laden with legal substance. Normal retirement age generally is the age specified under the plan at which the plan provides for normal retirement. The plan's age for normal retirement and the Act's definition of normal retirement age will coincide if the plan's age for normal retirement is set at age 65 or earlier. However, if the plan provides for a normal retirement age of over 65 for full vesting purposes, an individual's normal retirement age will be the later of age 65 or the employee's 10th anniversary of his commencement of participation.(fn26) Obviously, this does not govern the employer's choice of retirement age, but only affects the latest age at which full vesting is mandatory.

The term "normal retirement benefit" means the greater of the benefit provided to an employee at early retirement or at normal retirement age.(fn27) Again, a plan must provide that a participant be fully vested in his normal retirement benefit upon his attainment of normal retirement age. An employee's normal retirement benefit does not include...