Introduction

For many years, pensions were a reward for long and faithful service, at the discretion of the employer, and not guaranteed or funded. In 1972, Congress passed the Employee Income Retirement Security Act (ERISA), which subjected pensions to government regulation. In particular, a company's contributions to a plan, and the earnings on those contributions, became tax-free under ERISA as long as the plan maintains tax-favorable status.

The two primary types of pensions are defined contribution and defied benefit plans. Under a defined benefit plan, the pension is defined by a formula and usually payable as a monthly annuity until the participant's death. In a defined contribution plan, the individual's pension is in the form of an individual account balance. A common type of defined contribution plan is a 401(k). Under such a plan, employees may defer compensation, and the employer makes a contribution to the plan on the employee's behalf. These contributions are excluded from the employee's gross income in the year they are made and are not subject to taxation until distributed to the employee, usually at normal retirement age. If the employee terminates before normal retirement age, he or she may take the distribution as early as the plan's earliest retirement age. However, the distribution is subject to a 10 percent penalty, as well as taxes, if taken before age 55, unless the employee is disabled (as defined in Internal Revenue Code (IRC) 72(m)(7)).

There are two main classes of pension plans, those subject to ERISA and those that are not subject to ERISA. Generally speaking, all private pension plans are subject to ERISA. These are corporate and multi-employer union pension plans. Government plans (federal, state, and local) are not subject to ERISA. Quasi-governmental plans, such as state public school teachers' plans, are also not subject to ERISA. See Exhibit 16-1.

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