Ch6. Retirement Benefits — 401(k), Pension Plans, and ERISA Protections

Retirement Benefit System

ERISA (Employee Retirement Income Security Act): the primary federal law governing employer-sponsored retirement and welfare benefit plans. ERISA sets standards for participation, vesting, funding, and fiduciary responsibility.

Eligibility Requirements

Employer plans may require up to 1 year of service before an employee participates
1,000 hours of service in the eligibility year is the standard threshold
Employers with plans that offer immediate vesting may waive the service requirement

→ Employees with fewer than 1 year or fewer than 1,000 hours are generally not entitled to plan participation (unless the plan is more generous).

Calculating Retirement Benefits

Defined Contribution (DC) Plan — 401(k)

Account balance = employee contributions + employer match + investment returns

Employee contributions: pre-tax elective deferrals up to the IRS annual limit ( $23,000 for 2024;$ 30,500 for participants 50+)

Employer match example:

Employee contributes 5% of salary; employer matches 50% = 2.5% employer contribution
Annual contribution at $75,000 salary: employee$ 3,750 + employer $1,875 =$ 5,625

Defined Benefit (DB) Plan — Traditional Pension

Annual pension = (Years of service × Benefit accrual rate) × Final average salary

Example:

Service: 30 years
Accrual rate: 1.5%
Final average salary: $80,000/year

Annual pension = 30 × 1.5% × $80,000 = $36,000/year ($3,000/month)

Benefit Payment Timing

DC plans: vested account balance is accessible upon separation from service; early withdrawal (before age 59½) generally triggers income tax + 10% early withdrawal penalty.

DB plans: benefits typically begin at the plan’s normal retirement age (often 65). Many plans allow early retirement (reduced benefit) at age 55 with sufficient service.

In-Service Withdrawals and Loans

In-service withdrawals before retirement are generally prohibited, but hardship withdrawals may be permitted for:

Reason	Notes
Purchase of a primary residence	First-time homebuyer exceptions also available
Prevention of eviction / foreclosure	Immediate financial need required
Medical expenses not covered by insurance	Documented need
Tuition and education fees	Qualifying higher education
Bankruptcy / financial hardship	Demonstrated inability to meet expenses

After a hardship withdrawal, the vesting clock does NOT reset for employer contributions, but the withdrawn amount is no longer in the account.

Retirement Plan Types

US employers typically offer:

401(k) Plan (Defined Contribution)

Employee bears the investment risk. The employee decides how much to contribute and how to invest it.

Investment earnings belong to the employee
Highly portable: account moves with the employee when they change jobs (rolled into a new employer’s plan or an IRA)
Favored by employees who change jobs frequently or who want investment control

Pension Plan (Defined Benefit)

Employer bears the investment risk. The benefit is pre-determined based on a formula using years of service and compensation.

Employer funds and manages the plan assets; investment returns belong to the plan
Provides a predictable income stream in retirement
More common in public sector and unionized workplaces

IRA (Individual Retirement Account)

An individual retirement savings account not tied to an employer.

Traditional IRA: pre-tax contributions; taxes owed on withdrawal
Roth IRA: after-tax contributions; qualified withdrawals are tax-free
Annual contribution limit (2024): $7,000 ($ 8,000 for age 50+)
Rollover IRA: receives funds rolled over from a former employer’s plan, preserving tax-deferred status

DB vs. DC Comparison

Feature	DB (Pension)	DC (401k)
Investment risk	Employer	Employee
Benefit amount	Pre-determined formula	Depends on contributions + returns
Salary increase effect	Highly beneficial	Applies only to contributions that year
Portability	More complex	Simple — roll over to IRA or new plan
Best for	Long-tenured employees in stable industries	Mobile workers, investment-savvy employees

Receiving Retirement Benefits

Upon separation:

Employee separates → vested balance available for distribution or rollover
Roll over to a new employer’s plan or a traditional IRA to defer taxes
Taking a distribution before age 59½ triggers income tax + 10% penalty (exceptions apply)

Taxation:

Lump-sum distribution: ordinary income tax in the year received
Annuity / periodic payments: ordinary income tax as payments are received
Roth IRA / Roth 401(k) qualified distributions: tax-free

Taking distributions as periodic payments rather than a lump sum typically results in lower overall tax burden by spreading income across multiple years.

Remedies for Unpaid Retirement Benefits

Retirement plan benefits are protected under ERISA:

DOL complaint: ERISA § 502(a) civil action for benefits owed
Plan claim and appeal: every plan must have a written claims and appeals procedure
Federal court lawsuit: participant may sue for benefits, fiduciary breach, or ERISA violations
Statute of limitations: ERISA claims — generally 3 years from when the plaintiff knew or should have known of the breach (or 6 years from the breach)

Learning Checklist

I can explain the eligibility requirements for employer-sponsored retirement plans (1 year / 1,000 hours)
I can calculate a 401(k) account balance given contributions and employer match
I can list the hardship withdrawal conditions that allow early access to retirement funds
I can compare defined benefit and defined contribution plans
I can explain the tax advantages of rolling over a distribution into an IRA

OIYO Editorial