10.1 ERISA and Qualified Plans

The Employee Retirement Income Security Act

The Employee Retirement Income Security Act of 1974 (ERISA) is the federal law that sets minimum standards for most voluntarily established private-sector retirement plans. It does not require an employer to offer a plan, but once a plan exists, ERISA dictates how it must be run. The Series 7 tests ERISA mechanics constantly because registered representatives recommend employer-plan rollovers and IRA strategies that hinge on these rules.

ERISA does four things you must memorize: it sets participation and vesting standards, mandates disclosure to participants (the Summary Plan Description, or SPD), imposes fiduciary responsibilities, and created the Pension Benefit Guaranty Corporation (PBGC).

What ERISA Covers — and Does Not

A classic trap: a 403(b) plan at a public school is a governmental plan and is generally exempt from ERISA, while a 403(b) at a private 501(c)(3) charity is covered. Do not assume "403(b) = no ERISA."

Qualified vs. Non-Qualified Plans

A qualified plan meets Internal Revenue Code section 401(a) requirements and earns three tax advantages: the employer deducts contributions immediately, earnings grow tax-deferred, and employees defer pre-tax dollars that lower current taxable income. Distributions are then taxed as ordinary income.

To stay qualified, a plan must:

1. Be in writing and communicated to employees via the SPD.
2. Operate for the exclusive benefit of employees and their beneficiaries.
3. Pass nondiscrimination tests — it cannot favor highly compensated employees (HCEs), defined for 2026 as those earning above the IRS threshold (about $160,000) or owning more than 5%.
4. Meet minimum participation and coverage standards.
5. Follow vesting schedules at least as generous as ERISA minimums.

A non-qualified plan intentionally fails 401(a) so it can favor executives. Deferred compensation arrangements and executive bonus (Section 162) plans are examples. The employer gets no immediate deduction (deduction is delayed until the executive is taxed), the plan can discriminate freely, and assets remain subject to the employer's creditors. On the exam, "can discriminate in favor of key executives" almost always signals a non-qualified plan.

Vesting of Employer Contributions

Vesting is the nonforfeitable right to employer contributions. Employee salary deferrals are always 100% vested immediately — that fact is heavily tested. Only the employer's money is subject to a schedule, and ERISA permits two:

Under graded vesting, an employee with 4 years of service is 60% vested (20% + 20% + 20%). An employer may always be more generous (immediate vesting) but never more restrictive than these minimums. SIMPLE and SEP IRA employer contributions, by contrast, are immediately vested.

Fiduciary Duties Under ERISA

A fiduciary is anyone with discretionary authority over plan assets or administration — trustees, the plan administrator, and investment managers. ERISA fiduciaries owe four core duties:

• Duty of loyalty — act solely in participants' interests.
• Duty of prudence — act with the care, skill, and diligence of a prudent expert.
• Duty to diversify — minimize the risk of large losses.
• Duty to pay only reasonable plan expenses and follow plan documents.

Fiduciaries do not guarantee investment returns; they are judged on process, not outcomes. A breach can make the fiduciary personally liable to restore losses, and willful violations carry criminal penalties (fines and potential imprisonment).

The Pension Benefit Guaranty Corporation

The PBGC is a federal corporation funded by premiums paid by covered plans. It insures defined benefit pension plans only, guaranteeing a participant's monthly benefit up to an annually adjusted maximum if the plan terminates without enough assets. It does not insure defined contribution plans such as 401(k)s, because those are individual accounts with no promised benefit to backstop. Expect a question that lists 401(k), 403(b), IRA, and a pension — the pension is the PBGC answer.

Eligibility, Participation, and Top-Heavy Rules

ERISA also caps how long a plan can make employees wait. A qualified plan generally must let an employee participate once the employee reaches age 21 and completes one year of service (1,000 hours). A plan may impose a two-year wait only if it provides immediate 100% vesting — a common exam pairing. Long-term part-time employees who work at least 500 hours for the required number of consecutive years must also be allowed to defer under SECURE 2.0.

Qualified plans must also pass annual nondiscrimination testing (the ADP and ACP tests) to confirm that deferrals by HCEs are not disproportionate to those of rank-and-file workers. A plan that becomes top-heavy — where key employees hold more than 60% of plan assets — must provide minimum contributions to non-key employees. A safe harbor 401(k), which makes a mandatory fully vested employer match or contribution, is automatically deemed to pass these tests, a structure many small employers adopt.

Prohibited Transactions and Reporting

ERISA bars prohibited transactions between the plan and a "party in interest" — for example, the plan lending money to the employer, selling property to a fiduciary, or paying excessive fees to an affiliated broker-dealer. Engaging in one exposes the fiduciary to an excise tax and the duty to unwind the deal.

Fiduciaries must also satisfy disclosure and reporting obligations: furnish a Summary Plan Description (SPD) to participants, deliver an annual Summary Annual Report, and file Form 5500 with the Department of Labor each year. Participants are entitled to a benefit statement on request. For the Series 7, remember the chain of accountability: the plan sponsor and named fiduciaries are responsible for selecting and monitoring investments and service providers, and they cannot delegate away their oversight duty even when they hire an outside investment manager.