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Occupational pension schemes

Types of scheme What are the most common types of pension scheme provided by employers for their employees in your jurisdiction?

The most common type of retirement arrangement maintained by private employers is the 401(k) plan, which is a defined contribution plan under which an account is established for each employee participant, who determines how the funds in his or her account will be invested based on investment options offered by the plan.

This permits employees to defer a portion of their taxable income and pay tax on those deferrals and accumulated earnings when distributed after the termination of employment. Employers typically contribute:

  • matching contributions that match employee deferrals; or
  • non-elective contributions that are a percentage of employee compensation.

The benefit to which the participant is entitled is the balance in the account, for which the participant bears the investment risk.

The 401(k) plan is distinguished from a defined benefit plan, under which each participant is entitled to a fixed monthly payment for his or her life or the lives of him or her and a surviving beneficiary. The amount of the monthly payment is determined by a formula, typically based on compensation from and service with the employer. Defined benefit plans have lost popularity over the decades and are now typically offered only to collectively bargained employees and governmental employees, although they are increasingly losing favour in these sectors as well.

Statutory framework Is there a statutory framework governing the establishment and operation of occupational pension plans?

Yes, the statutory framework is the Employee Retirement Income Security Act (ERISA) 1974, as amended, and the corresponding provisions of the Internal Revenue Code 1986, as amended.

What are the general rules and requirements regarding the vesting of benefits?

Employee contributions or deferrals must be fully vested at all times. Employer contributions to a 401(k) or other defined contribution plan must vest according to a three-year cliff vesting schedule or a two-to-six-year graded vesting schedule. Employer provided benefits under a different type of retirement arrangement, called a defined benefit plan, must vest according to a five-year cliff vesting schedule or a three-to-seven-year graded vesting schedule.

What are the general rules and requirements regarding the funding of plan liabilities?

The funding of defined benefit plans is based on statutory requirements designed to ensure that the plan has sufficient assets – determined on an actuarial basis – to pay benefits when due under the terms of the plan. Funding of 401(k) or other defined contribution plans is based on the contributions required by the terms of the plan and generally must occur shortly after the end of the year in which participants’ rights to those contributions accrue.

What are the tax consequences for employers and participants of occupational pension schemes?

Employers get an income tax deduction for contributions for the year in which those contributions are made. Employees generally pay tax on benefits only when they are distributed.

Is there any requirement to hold plan assets in trust or similar vehicles?

Plan assets must be held in trust and can revert to the employer only in limited circumstances.

Are there any special fiduciary rules (including any prohibited transactions) in relation to the investment of pension plan assets?

ERISA imposes strict standards of conduct on fiduciaries responsible for the investment of pension plan assets, including a duty of prudence and a duty to act solely in the interest of the pension plan and its participants and beneficiaries.

ERISA also prohibits a wide range of transactions between pension plans and related parties and transactions that may involve conflicts of interest. Fiduciaries must ensure that plan investments comply with the conditions of applicable prohibited transaction exemptions.

Is there any government oversight of plan administration and/or insurance coverage for plan benefits in the event of an employer’s insolvency?

The Internal Revenue Service and the US Department of Labour regulate the form and administration of retirement plans. The Pension Benefit Guaranty Corporation insures benefits under defined benefit plans – up to a specified level – in the event that an employer becomes insolvent or any other inability to maintain and fund the plan arises. There is no insurance for 401(k) or other defined contribution plans.

Are employees’ pension rights protected in the event of a business transfer?

Employees’ pension rights must be funded and are non-forfeitable, to the extent accrued and vested, in the event of a business transfer. Certain business transfers may require accelerated vesting.

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