What are the basic requirements for vesting under ERISA?

ERISA Section 203 establishes the minimum vesting standards for an ERISA-covered pension plan. Under that section, each pension plan must provide that an employee’s right to his normal retirement benefit is nonforfeitable upon the attainment of normal retirement age. ERISA Section 203(a)(1) states that an employee’s accrued benefit derived from the employee’s own contributions must, at all times, be conforfeitable.

Section 904 of the Pension Protection Act of 2006, has altered the mandatory vesting requirements for qualified benefit plans by eliminating ERISA Section 203(a)(4) and IRC Section 411(a)(12). The PPA also amended ERISA Section 203(a)(4) and IRC Section 411(a)(2) by providing that for plan years beginning after 2006, employer non-elective contributions must vest at least as rapidly as the mandated vesting schedules for employer matching contributions—that is, either a three-year cliff vesting schedule or a schedule of 20 percent after two years, 40 percent after three years, 60 percent after four years, 80 percent after five years, and 100 percent after six years. 

IRS Notice 2007-7 has clarified that employer discretionary contributions remitted to a plan trust prior to 2007 may remain under the pre-PPA vesting provisions of either a five-year cliff vesting schedule or a 3/20 schedule graduating at 20 percent per year after three years and culminating in 100 percent vesting after seven years. 

Most qualified retirement plans provide for a graduated vesting schedule on a “2/20” basis. That is a vesting schedule that provides for 2 percent vesting after two years of credited service and then increases the vesting percentage by 20 percent for each additional year of credited service until the participant becomes 100 percent vested. However, employer-matching contributions (as defined under IRC Section 401(m)(4)(A)) must be vested on a three-year cliff or six-year graded vesting schedule.

For defined contribution plans, the “accrued benefit” is the balance of assets allocated to the participant’s individual account. For purposes of a defined benefit plan, “accrued benefit” is defined as the employee’s accrued benefit as determined under the plan and expressed in the form of an annual benefit commencing at normal retirement age.

Both ERISA and the Internal Revenue Code generally prohibit any plan amendment that has the effect of decreasing accrued benefits under a plan. This would include any amendment increasing the vesting schedule. The IRS takes this provision very seriously and has disqualified plans for violations of this prohibition. Such violations are often referred to as the “death penalty” for qualified plans.