Regulation of state and supplementary pension schemes in United States: overview

A Q&A guide to pensions law in the United States.

The Q&A gives a high level overview of the key practical issues including: state pensions; supplementary pensions; funding and solvency requirements; tax on pensions; business transfers; participation in pension schemes; and employer insolvency and overall scheme solvency.

To compare answers across multiple jurisdictions, visit the Pensions: Country Q&A tool.

The Q&A is part of the global guide to pensions law. For a full list of jurisdictional Q&As visit www.practicallaw.com/pensions-guide.

Contents

Pensions

State pensions

1. Do employers and/or employees make pension contributions to the government in your jurisdiction?

Contributions paid to the government

The only governmental pension plan for private employers is the federal social security programme providing retirement benefits to retired employees. Employers and employees make contributions to the programme.

Taxation of contributions

Social security's old-age, survivors, and disability insurance (OASDI) programme and Medicare's hospital insurance programme are financed primarily by employment taxes. Tax rates apply to earnings up to a maximum amount, which increases annually.

The OASDI tax rate for wages paid in 2016 is set by statute at 6.2% for employees and 6.2% for employers, and at 12.4% for self-employment income. The cap on income which is taxed for OASDI purposes is US$118,500. The Medicare Hospital Insurance tax rate for wages paid in 2016 is 1.45% for employers and employees, and 2.9% for self-employment income. In addition, for incomes over US$200,000 (or US$250,000 for joint filers), there is an additional Medicare tax of 0.9% of income. The Medicare taxes are not capped.

Monthly amount of the government pension

The monthly amount of social security payments varies depending on calculations based on employees' lifetime earnings.

 

Supplementary pensions

2. Is it common (or compulsory) for employers to provide access, or contribute, to supplementary pension schemes for their employees? If they do, are they:
  • Occupational (that is, linked to an employment or professional relationship between the plan member and the entity that establishes the plan)?

  • Personal (that is, not linked to an employment relationship, established and administered directly by a pension fund or a financial institution acting as pension provider, where individuals independently purchase and select material aspects of the arrangements, though the employer may make contributions)?

Although not required, many employers sponsor private pension plans and retirement savings plans for their employees. Significant tax advantages for establishing and maintaining certain employee benefit plans motivate employers to provide additional benefits to their employees. Every employee benefit plan must be established and maintained under a written instrument (section 402, Employee Retirement Income Security Act 1974) (ERISA). ERISA generally prohibits assignment and alienation of ERISA plan benefits.

Employers do not contribute to personal pensions in the US.

 
3. Where supplementary schemes are provided, do these schemes provide pensions, the value of which:
  • Is linked to the employee's salary (defined benefit)?

  • Is linked to employer and/or employee contributions and investment return on those contributions (defined contribution)?

Linked to the employee's salary

See below, Linked to employer and/or employee contributions.

Linked to employer and/or employee contributions

Retirement benefits in the US generally cannot be determined at inception. They are either:

  • Defined contribution plans where the benefit depends on the amount of contributions (which vary as salary amounts change) and investment performance.

  • Defined benefit plans where the benefit is based on years of service and pay. This type of plan may have as its goal a percentage of final average pay or career average pay which is payable as a life annuity, these plans are becoming rare in the US with many plans being frozen or terminated.

 
4. For supplementary pensions:
  • Is there a minimum period of service before workers are entitled to receive vested rights?

  • Are there any legal requirements for schemes or providers to index pensions in payment and/or revalue pension rights in deferment?

Minimum period of service

There is no legally mandated minimum vesting period. However, many plans contain vesting schedules which are generally between two and five years. The vesting schedule will apply solely to employer contributions made to the plan, as opposed to the employee's own contributions which are always fully vested.

Legal requirement to index

There is no legal requirement for employers to index pensions or revalue pension rights in deferment. Few schemes do so.

 

Funding and solvency requirements

5. In relation to supplementary schemes, are these generally funded or unfunded? If funded, are there any solvency requirements on the sponsoring employer or provider?

Funded or unfunded?

Qualified plans which are broad based tax favoured plans must be funded and placed in a trust which keeps the scheme's assets separate from those of the employer. Supplementary pension schemes for high paid employees cannot as a matter of law be placed in a trust which will shield assets from the employer's creditors. Some of these plans are placed in trusts which do not protect employees from creditor claims but do protect employees from a solvent employer's rescission of its promise to pay plan benefits.

Solvency requirements for funded schemes

Generally, defined contribution plans are fully funded at all times as the benefits promised do not exceed the contributions to the scheme plus investment gains. However, defined benefit plans are often underfunded and there are funding requirements which require minimum contribution levels which depend upon the scheme's investment performance, prevailing interest rates, current funding levels and actuarial factors.

 
6. In relation to access for members to the funds in their supplementary pension scheme:
  • To what extent can members transfer their funds to another pension scheme?

  • How do members normally take the benefit of their funds (for example, lump sums, income withdrawals (drawdown), life annuity arrangements)?

  • What are the legal restrictions upon access to the funds (for example, age)?

  • What are the common arrangements for early retirement and ill-health retirement?

  • Are dependants of deceased members entitled to receive benefits payable on the member's death? What form do these commonly take?

Member's transfer of funds

Generally, members can "roll over" defined contribution plan proceeds from one employer's plan into another employer's plan or to an "individual retirement account".

Taking pension benefits

Plan participants generally take pension benefits in the form of lump sums, instalments or annuities. Annuities are most popular under defined benefit pension plans and lump sums are most popular under defined contribution plans. Annuities which are paid out over the life of a plan participant and his or her spouse are "normal forms of benefit" under a defined benefit plan (and certain other plans) and the spouse must agree to a distribution in another form. Only lump sum payments can be "rolled over" to another employer's plan or an "individual retirement account (IRA)", which is a personal retirement plan.

Legal restrictions

Generally, amounts cannot be distributed from a plan while an individual remains employed. Exceptions exist for plan loans, withdrawals on account of "hardship", and withdrawals after age 59 and a half. Although plan benefits may be accessed after termination of employment, income tax plus a 10% penalty tax will generally be applied to the distribution, which is not payable prior to a retirement or early retirement age, or if the distribution is "rolled over" into another retirement plan or IRA.

Early and ill-health retirement

Plans can establish early retirement ages and many do, especially defined benefit plans, where the attainment of early retirement age may result in a benefits subsidy which is unavailable to those retiring before attaining early or normal retirement age. The normal retirement age is generally age 65. Early retirement is generally available to those who attain both a certain age (55 or 62 is common) and a certain number of years of service (generally five or ten years of service). Generally, ill health or "long-term disability" as it is called in the US, permits plan participants to become fully vested in their accrued benefits.

Dependants' benefits

Depending upon the form of benefit elected by a participant, a beneficiary may or may not receive a benefit on the participant's death. Some plans permit annuity payouts and when they do, there is generally the ability for a participant to elect a life annuity. He or she may need spousal consent to make this election if the annuity is provided under certain types of plans (largely defined benefit plans) but if such election is made, there is generally no further benefit payable after death. Under most other forms of distribution, there will be benefits payable to a surviving beneficiary who is named in the plan. If a participant is married, he or she will need to procure the consent of the spouse in order to name a beneficiary other than the spouse.

 
7. Is there a regulatory body that oversees the operation of supplementary pension schemes? Do any other governance regimes apply to supplementary pension schemes?

Regulatory body

The administration of ERISA is divided as follows:

  • Title I contains rules for reporting and disclosure, vesting, participation, funding, fiduciary conduct and civil enforcement, and is administered by the Employee Benefits Security Administration within the DOL.

  • Title II is administered by the Internal Revenue Service (IRS).

  • Title III concerns jurisdictional matters and is enforced and regulated by both the DOL and the IRS.

  • Title IV covers the insurance of defined benefit pension plans and is administered by the Pension Benefit Guaranty Corporation (PBGC).

Regulatory framework

See above, Regulatory body.

Other key governance requirements

See above, Regulatory body.

Penalties for non-compliance

Generally, the sanction for a non-compliant plan is "disqualification" which would mean that the employer's and employee's tax subsidies would be invalidated. This is a very harsh sanction and therefore rarely imposed. Instead, when there is a lapse in administration, the regulatory agency generally will assert a fine or penalty which can be very subjective in nature.

 

Tax on pensions

8. Are any tax reliefs available on contributions to supplementary pension schemes (by the employer and employees)?

Tax relief on employer contributions

Not applicable (see below, Tax relief on employee contributions).

Tax relief on employee contributions

Several types of retirement plans receive favourable tax treatment. Individual retirement accounts (IRAs) comprise a special class of retirement accounts providing varying tax benefits.

401(k) and 403(b) plans (which refer to the sections of the Internal Revenue Code authorising their establishment) are "qualified plans" that permit participants to defer taxes on a portion of their compensation, which is contributed, at their election, to the plan. Plan contributions are made in lieu of the participant's receipt of taxable pay. Tax law places numerous restrictions on 401(k) plans, including limits on annual contributions and penalties for early withdrawals before employees have reached a certain age. There are also supplemental "non-qualified" plans that employers can establish, which permit tax deferral of greater amounts than can be contributed to a qualified plan. These arrangements must contain strict rules relating to the manner in which income may be deferred, the timing of distributions and permissible distribution triggers.

 
9. Are there any approval or registration requirements with the local tax authority where a supplementary scheme is established?

No, there are not supplementary schemes in the US.

 
10. What is the tax treatment of investments made by the scheme?

Investments are not taxed until distributed. All investment gains are taxed deferred which is a valuable component of participating in a retirement plan.

 
11. What is the tax treatment of pension and lump sum payments made to members?

All payments are treated as ordinary wage income. However, lump sum payments can be rolled over to preserve tax deferral.

 
12. Are there any other applicable tax charges on schemes?

If amounts are paid out before retirement age and not rolled over, there is generally a 10% penalty tax, as well as income tax that applies to the distribution.

 

Business transfers

13. Is there any legal protection of employees' pension rights on a business transfer?

Automatic transfer of pension rights

In the US, supplementary pension plans are called non-qualified plans. Generally, there is a clause in these plans that provides that benefits which have accrued under the plan (which generally takes into account the amount accrued, taking into account the participant's age, service and compensation on the date of any plan amendment or termination) are protected, but any future benefits are not protected. Generally, employers have the unfettered right to change or terminate these plans at any time, irrespective of whether there is any business transfer occurring.

Other protection for pension rights

Not applicable (see above, Automatic transfer of pension rights).

 
14. Can the following participate in a pension scheme established by a parent company in your jurisdiction:
  • Employees who are working abroad?

  • Employees of a foreign subsidiary company?

Employees working abroad

The IRC contains complicated rules governing US retirement plan and tax benefits for individuals employed abroad. Individuals working for a foreign branch or affiliate controlled by a US employer can continue to participate in the US retirement plan. If employees are US citizens, they also receive the tax relief referred to in Question 4. However, employees' participation in these plans is more complicated if they do not work for US or US-controlled companies.

Employees of a foreign subsidiary company

Foreign nationals working for a foreign subsidiary company of a US employer can participate in the subsidiary's retirement plan. Because the foreign national is the US employer's employee, participation is generally automatic and even if they are not their employee, the employer can extend the plan. Because the foreign national is not a US citizen, the employee would not receive the tax relief referred to in Question 4.

 
15. Is there any protection provided for pension scheme benefits where the sponsoring employer becomes insolvent? If so, who provides the protection, and how does this operate? If the scheme itself is underfunded, are there any funding obligations on connected or associated legal entities?

There is limited protection offered to pension plan participants in the US through a government insurance programme run by a federal agency called the Pension Benefit Guaranty Corporation (PBGC). If an employer becomes insolvent, the PBGC will guarantee each participant's benefit up to a maximum monthly amount. The monthly maximum, which is indexed for inflation, will differ by the age of the pension plan participant and the manner in which the benefit is being taken.

For 2016, the limit is US$5,011 per month for a participant who is aged 65 who elects a straight life annuity. If a participant's accrued pension exceeds the limit, there may be little recourse for the individual if his employer becomes insolvent. There have been concerns that the PBGC may itself face insolvency if the pension funding situation in the US does not improve.

 

Online resources

Social Security Administration

W www.ssa.gov

Description. Contains information regarding disability and Forms W-2 and W-4.

Internal Revenue Service

W www.irs.gov

Description. Contains information regarding the IRC and EINs.

Equal Employment Opportunity Commission

W www.eeoc.gov

Description. Contains information regarding Title VII, ADEA, ADA, and EEO-1 Reports.

Department of Labor

W www.dol.gov

Description. Contains information regarding the FMLA, FLSA, WARN Act, and ERISA.

Immigration and Customs Enforcement

W www.ice.gov

Description. Contains information regarding I-9s and immigration issues.

National Labor Relations Board

W www.nlrb.gov

Description. Contains information regarding the NLRA and collective bargaining obligations.

Occupational Health and Safety Administration

W www.osha.gov

Description. Contains information regarding workplace health and safety requirements.



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Peter A Susser

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