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How has vesting changed since passage of Employee Retirement Income Security Act?

Since the enactment of ERISA in 1974 vesting status is attained sooner for most workers and is more easily obtained for mobile workers

Provisions of employer-financed retirement plans have been changed to reflect the statutory requirements of the Employee Retirement Income Security Act (ERISA), enacted in 1974, and several other laws passed since that time. These plans will experience further revisions as terms of the Tax Reform Act of 1986 become effective. The laws largely affect a retirement plan's vesting schedule-the rate at which a participant's future retirement benefits become guaranteed. Vesting provisions are very important in an economy with a mobile Labor force; once specific requirements are met, these provisions essentially guarantee a worker the right to future benefits. These provisions allow a worker to terminate service before he or she is eligible for retirement without losing accrued benefits. In addition, vesting provisions can guarantee benefits to the spouse of an employee who dies before retiring. However, vesting increases the likelihood of eventual pension payments, thereby raising the cost to employers of providing employee benefits.

This article discusses the vesting provisions of two types of plans-defined benefit pension plans and defined contribution plans. A defined benefit pension plan contains a formula for determining retiree benefits (for example, the formula may designate a dollar amount or a percentage of annual salary times years of service). A defined contribution plan specifies the employer's contribution to a retirement or savings fund (for example, a percentage of annual salary), but not the eventual benefit amount. Instead, benefits depend on amounts contributed to the fund plus the fund's investment earnings. The two major forms of defined contribution plans discussed in this article are savings and thrift plans (in which employees typically contribute a portion of their earnings to a fund, which is matched in whole or in part by the employer) and deferred profit-sharing plans (in which employers typically contribute a portion of profits to a fund, regardless of the level of employee contribution). Defined contribution plans often have more liberal vesting schedules, compared with defined benefit plans.

Changes in vesting provisions in defined benefit pension plans are traced in this article using results from two Bureau of Labor Statistics surveys, one conducted in 1974 before enactment of ERISA, and the other in early 1986, just before passage of the Tax Reform Act. Essentially, ERISA made vesting a universal feature of the plans studied here, For many plans which already had vesting provisions, ERISA called for revising the timing schedules to guarantee benefits after fewer years of service with the employer, The Tax Reform Act will likewise have a large impact on pension plans; most of the plans studied in the 1986 Employee Benefits Survey will have to be revised to conform to the vesting standards spelled out in that act. Vesting provisions

Vesting schedules specify the rate at which employees earn rights to the employer contributions to a plan. Employees are always fully and immediately vested in their own contributions to the plan.' The four standard types of vesting schedules are:

* Immediate full- participants have immediate rights to

all accrued benefits. This schedule may be found in either defined benefit or defined contribution plans.

* Deferred full (also kno"cliff vesting")-partici

pants are granted full (100-percent) rights to all accumulated benefits only after completing the necessary service period (such as 10 years). However, if employment is terminated before the required service is completed, the benefits are forfeited. This schedule may be found in either defined benefit or defined contribution plans, * Deferred graded-participants gradually become

vested, until 100-percent status is achieved. To illustrate: A schedule may call for 50-percent vesting after 5 years of service and then 10 additional percentage points in each of the next 5 years. An employee leaving the company after 5 years of service would have a guaranteed right to 50 percent of his or her accumulated benefits. This schedule may be found in either defined benefit or defined contribution plans.

* Class year-employer contributions for a particular year (or class) are vested after a certain time, say, 2 or 3 years. For example, if the class-year schedule calls for vesting after 2 years, contributions made in 1986 may become nonforfeitable in 1988. This schedule is found only in defined contribution plans.

Determining vesting rights. Also important is how pension plans count years of service toward satisfying vesting requirements. ERISA required all service accrued after age 22 to count for vesting purposes; the "vesting" age was reduced to 18 by the 1984 Retirement Equity Act.'

Regardless of how vesting rights are determined, they apply solely to benefits accumulated at termination of employment. If an employee leaves a job prior to retirement, the eventual benefits are, of course, usually much less than they would be if the employee had continued working until retirement. Also, vested benefits are not payable until a terminated employee has reached a pension plan's early retirement age, at the least. For example, an employee who is vested in a plan permitting retirement at age 55, and who leaves the employer at age 35 after meeting the necessary service requirement, will have to wait 20 years for the benefits.

Other pension plan provisions may also affect how vested benefits are received. These provisions, such as rules governing breaks in service (when employees temporarily leave employment) and survivors' right to annuities, are not examined in this article.

Vesting provisions in 1974

Before passage of ERISA 14 years ago, there were no statutory requirements for vesting,3An employer who provided a pension plan determined if when, and under what conditions employees obtained vested rights to the accrued benefits.

The 1974 survey of defined benefit pension plans with 100 or more active workers provides information on vesting practices before the passage of ERISA. This survey covered plans with approximately 23 million private sector plan participants.

According to the survey, 13 percent of participants were in defined benefit plans without vesting provisions; 11 percent were in plans requiring 20 years or more of service before becoming eligible for full vesting; and 34 percent were in plans requiring 15 to 19 years. (See table 1.) Age restrictions also were common; for example, 1 of 5 participants under cliff vesting schedules was required to be 41 or older.

Impact of legislation

Employee Retirement Income Security Act (ERISA).

Restrictive vesting provisions, such as those reported in the 1974 survey, were among the major concerns addressed in the Employee Retirement Income Security Act of 1974,' which established comprehensive requirements for employee benefit plans, including minimum standards for vesting provisions. (See exhibit 1.) ERISA prescribed several minimum vesting schedules, including a 10-year cliff vesting standard and two graduated vesting alternatives. (See table 2.) In addition, a 5-year minimum class-year schedule was established for defined contribution Ians.

Nearly three-fourths of the workers in the 1974 definedbenefit pension survey were in plans that did not meet ERISA standards, either because the plans did not provide vesting or the vesting schedules were more restrictive than the ERISA standards, as shown in the following tabulation:

Slightly more than one-fourth of the workers were in plans that met ERISA'S Vesting schedule requirements. One of three workers under cliff vesting schedules was in a plan that met or exceeded the standards, compared to 1 of 8 workers under graduated schedules.

Information from the Current Population Survey (cps)' suggests that the proportion of retirement plan participants who were fully or partly vested in their plan increased after the passage of ERISA. According to the cps, the proportion of retirement plan participants who said they were vested rose from 32 percent in 1972 (before ERISA) to 48 percent in 1979, and to 51 percent in 1983.

More dramatic is the growth of vesting among covered workers with 5 to 9 years of service with their current employer. The 1972 cps reported that 25 percent of these respondents said they had vested status; 59 percent were not vested. In 1979, 42 percent said they were vested, and 41 percent were not, (Among workers with 5 to 9 years of employment in both the 1972 and 1979 cps, approximately one-sixth did not know if they were vested.)

Retirement Equity Act Vesting standards were tightened when ERISA was revised 10 years later by the Retirement Equity Act of 1984. Although best known for provisions improving the accessibility of retirement benefits to spouses, this statute also lowered from 22 to 18 the age after which employees must be given credit toward vesting.

The BLS 1986 Employee Benefits Survey, which covered 21 million full-time workers, shows that 81 percent of the participants in defined benefit pension plans in medium and large firms had schedules which counted all years of service toward vesting. The following tabulation shows the percent of the participants in defined benefit plans in medium and large firms providing cliff and graded vesting, and years of service included toward vesting requirements, 1986:

As shown, relatively few participants were in plans that did not follow the new Retirement Equity Act rules. For plans which stipulated an age requirement older than 18, the Retirement Equity Act standards did not become effective until after the date of the 1986 Employee Benefits Survey.'

Vesting provisions in 1986

Defined benefit plans. Data from the 1986 Employee Benefits Survey show the influence of ERISA on vesting schedules, According to the survey, 76 percent of fulltime employees in medium and large firms were covered by a defined benefit pension plan in 1986. Nearly all of them were in plans that used the minimum time for vesting specified by ERISA. (See table 2.) The vast majority were in plans with cliff vesting schedules, nearly all of which specified the maximum time allowed by ERISA for this type of vesting, 10 years of service. Only 13 percent had graduated schedules; about half of them were in plans with vesting schedules more liberal than those prescribed by ERISA. OVerall, 1 of 10 participants was in a plan providing vesting time schedules more liberal than those prescribed by ERISA.

Defined contribution plane. The 1986 Employee Benefits Survey also examined the characteristics of defined contribution plans, including provisions affecting vesting of employer con-tributions to savings and thrift and deferred profit-sharing plans. The survey found that 28 percent of employees participated in savings and thrift plans, and 21 percent in deferred profit-sharing plans.

The following tabulation compares vesting provisions of defined benefit pension plans with the two types of defined contribution plans studied. The data (in percent) relate to medium and large firms in the first half of 1986:

While the majority of the participants in defined benefit pension plans had cliff vesting, only a minority of those in savings and thrift and profit-sharing plans had such provisions. When the defined contribution plans had cliff vesting schedules, the provisions nearly always called for participants to be vested within 5 years. (See table 3.)

Although rare in defined benefit plans, immediate vesting accounted for slightly more than one-quarter of the participants in savings and thrift and deferred profitsharing plans.

Graduated vesting schedules, ranging from 5 to 15 years, accounted for two-thirds of the workers in profitsharing plans. In savings and thrift plans, graduated vesting schedules applied to one-fourth of the participants, most of whom achieved full vesting after 5 years of service.

Class-year vesting was a significant provision in savings and thrift plans, with most participants granted full vesting 2 or 3 years after the employers' contributions were made. This form of vesting schedule was rare in deferred profit-sharing plans.

In summary, defined contribution plans required generally shorter vesting periods than did defined benefit plans. In defined contribution plans, vesting schedules varied widely, but the large majority of participants in defined benefit plans were subject to a 10-year cliff vesting schedule. (As discussed later, many of the vesting variations between the two plans will be reduced as provisions of the 1986 Tax Reform Act become effective.) Future vesting revisions

The 1986 Tax Reform Act provides for changes in vesting schedules created under ERISA. The changes become effective for plan years beginning after December 31, 1988, and apply to all accrued benefits earned before and after the effective date. The effect of the Tax Reform Act on both cliff and graduated schedules is to require fewer years of service for vesting.

Based on the 1986 Employee Benefits Survey, the vesting schedules of nearly all defined benefit plans in medium and large firms will have to be revised to comply with the Tax Reform Act. Many participants in defined contribution plans also will be affected by the more rapid vesting schedules required by the act. The following tabulation shows the proportion of participants in plans which do and do not meet the vesting requirements of the 1986 Tax Reform Act:

As shown, 95 percent of defined benefit pension participants were in plans that will have to be revised. This is primarily because of the predominance of 10-year cliff vesting in 1986 plans, and also because of the number of participants who needed 10 years or more of service under graduated schedules.

Sixty percent of participants in deferred profit-sharing plans were under more restrictive schedules than those allowed by the Tax Reform Act. They were primarily participants who had graduated vesting provisions calling for more than 7 years of service before full vesting. In contrast, one-third of the savings and thrift plan participants had vesting requirements not meeting the Tax Act standards; they were primarily under class-year vesting schedules.

VESTED STATUS HAS BECOME EASIER TO OBTAIN over the last 15 years for a growing population of mobile workers. ERISA, in 1974, established years of service requirements specifying the time by which employees were to be vested in both defined benefit and defined contribution plans.

By 1986, nearly all plan participants studied in the BLS Employee Benefits Survey of medium and large private sector firms were in either a defined benefit pension plan or a defined contribution plan that met vesting standards set by ERISA and the Retirement Equity Act. Vesting schedules required fewer years of service than those schedules reported in the BLS 1974 survey, conducted before the enactment of ERISA.

The 1986 Employee Benefits Survey suggests that tax reform will have a substantial impact on vesting provisions. As with the earlier laws, the 1986 Tax Reform Act was intended to ensure that employees with pension plans vest sooner in their benefits.' However, it is important to note that the accumulated pension benefits may not be large, particularly for workers who make many job changes during their careers, Also, many workers are not, and will never be, vested in private retirement plans because their employers do not offer one.
COPYRIGHT 1988 U.S. Bureau of Labor Statistics
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Author:Graham, Avy D.
Publication:Monthly Labor Review
Date:Aug 1, 1988
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