ERISA Protects the People Inside Workplace Plans

ERISA, the Employee Retirement Income Security Act of 1974, is the federal law that sets minimum standards for most retirement and health plans offered by private-sector employers. It does not require any employer to offer a plan, but once a plan exists, ERISA governs how it is run, who may manage its money and what participants are entitled to know.

The law was passed after a series of pension failures left workers with nothing, most famously when the Studebaker car company closed in 1963 and thousands of employees lost most of their promised benefits. ERISA responded with rules on funding, vesting, disclosure and conduct, and created a federal insurer for pensions.

For advisers, ERISA matters whenever they select plan investments, advise participants or recommend moving money out of a plan. For the full route from the exam to a career giving that advice, our complete guide to how to become an investment adviser representative covers every step.

Make January your breakthrough month with the FRC Series 65 playlists on YouTube

What ERISA Covers and What It Does Not

ERISA applies to employee benefit plans set up by private employers and unions, including 401(k) plans, profit-sharing plans, traditional pensions and cash balance plans. It also covers many employer health and welfare plans, although retirement plans are the focus of the exam.

Several important plans sit outside ERISA. Government plans for federal, state and local employees are exempt, as are most church plans and plans maintained solely to comply with workers’ compensation or unemployment laws.

Individual retirement accounts are generally not ERISA plans, because an individual opens them rather than an employer. IRAs are still subject to prohibited transaction rules under the Internal Revenue Code, and the Series 65 Exam Preparation course at FRC shows how the exam tests the line between ERISA plans, IRAs and government plans.

The Four Titles of ERISA

ERISA is organised into four titles. Title I protects participants’ rights, setting standards for participation, vesting, funding, reporting, disclosure and fiduciary conduct, and is enforced mainly by the Department of Labor.

Title II amends the Internal Revenue Code, linking ERISA’s standards to the tax benefits plans receive, and is administered by the IRS. Title III covers jurisdiction and administration, coordinating the agencies involved.

Title IV created the Pension Benefit Guaranty Corporation, which insures most private-sector defined benefit pensions. Our comparison of defined benefit vs defined contribution plans explains why that insurance applies to pensions but not to 401(k) investment losses.

Who Is a Fiduciary Under ERISA

ERISA uses a functional test: a person is a fiduciary to the extent they exercise discretionary authority or control over plan management or assets, give investment advice for a fee, or have discretionary responsibility for plan administration. A title does not decide it; what the person actually does decides it.

Every plan must have at least one named fiduciary, usually the employer or a committee, with authority over how the plan operates. Trustees who hold plan assets, investment managers who select investments and anyone who gives paid investment advice can all be fiduciaries, while purely clerical service providers usually are not.

Plan sponsors often hire outside professionals and describe their roles by the ERISA section that defines them. The three most common appear in the table below.

ERISA Fiduciary Roles Compared

The Core Fiduciary Duties

ERISA’s section 404 sets out four duties. The duty of loyalty requires fiduciaries to act solely in the interest of participants and beneficiaries, for the exclusive purpose of providing benefits and paying reasonable plan expenses.

The duty of prudence requires them to act with the care, skill and diligence that a prudent person familiar with such matters would use, often called the prudent expert standard. The duty to diversify requires plan investments to be spread to minimise the risk of large losses, the principle of diversification written into law.

The fourth duty is to follow the plan documents, so long as they are consistent with ERISA. Fiduciaries who breach these duties are personally liable to restore any losses to the plan, which is a far stricter consequence than most investors expect and a defining feature of the fiduciary role under ERISA.

Worked Example: Why Fees Are a Fiduciary Issue

A participant has $100,000 in a 401(k) and adds nothing more for 30 years. The plan’s investments earn 7 percent a year before costs.

Step one: in a plan charging 0.25 percent a year, the net return is 6.75 percent, and the balance grows to about $709,600. Step two: in a plan charging 1.00 percent, the net return is 6 percent, and the balance grows to about $574,300.

Step three: the difference is about $135,300, nearly one and a half times the original balance, lost to costs alone. Because fees compound against the participant just as returns compound in their favour through compound interest, excessive fees have been the basis of many lawsuits against plan fiduciaries.

ERISA does not require the cheapest option. It requires a prudent process: comparing costs and services, documenting the decision and reviewing it regularly.

Study ERISA and Retirement Plans With FRC

ERISA links fiduciary duty, plan design and client advice, and questions on it often hide inside scenarios about rollovers or plan investments. Our Series 65 course builds the rules step by step, from fiduciary definitions to prohibited transactions, with practice questions throughout.

Consider studying with FRC for every exam on your route. Explore our USA exam courses, from the SIE through the Series 7, Series 63 and Series 65.

To take advantage of the membership, explore FRC Professional Membership, which gives you a verified Digital Profile that shows employers your real-time course progress, together with the Video Resume. Current offers are on our membership deals page.

Prohibited Transactions

ERISA bans certain transactions between a plan and a party in interest, a group that includes the employer, plan fiduciaries, service providers, unions and close relatives of those people. Banned dealings include sales or leases of property, loans, the provision of services and any transfer of plan assets for the benefit of a party in interest.

Fiduciaries are also barred from self-dealing, such as using plan assets in their own interest or receiving payments from a third party in connection with a plan transaction. These rules apply even when the price is fair, because the conflict itself is the problem.

Worked example: an employer sells a building worth $200,000 to its own pension plan. The first-tier excise tax under the Internal Revenue Code is 15 percent of the amount involved, or $30,000, and if the transaction is not corrected in time, a second-tier tax of 100 percent, or $200,000, can apply. Statutory and administrative exemptions allow some transactions, such as reasonable payments for necessary services and participant loans that meet the plan’s rules.

Section 404(c) and Participant-Directed Plans

In a 401(k), participants usually choose their own investments. Section 404(c) gives fiduciaries relief from liability for losses that result from a participant’s own investment choices, provided the plan meets certain conditions.

The plan must offer at least three diversified investment options with materially different risk and return characteristics, allow participants to change their investments at least quarterly, and give them enough information to make informed decisions. Relief does not cover the fiduciary’s choice of which funds go on the menu, which must still be prudent and monitored.

For participants who never make a choice, plans can use a qualified default investment alternative, usually a target-date or balanced fund, and receive similar protection. Good asset allocation in the default option therefore shapes the outcomes of millions of workers who never revisit their accounts.

Reporting, Disclosure and Bonding

Most ERISA plans must file an annual report with the government on Form 5500, covering the plan’s finances, investments and operations. Participants must receive a summary plan description explaining how the plan works, regular benefit statements and disclosures of the fees they pay.

Service providers must also disclose their compensation to plan fiduciaries under ERISA section 408(b)(2), so that fiduciaries can judge whether fees are reasonable. A fiduciary who never asks what a plan is paying cannot show a prudent process.

Everyone who handles plan funds must be covered by a fidelity bond of at least 10 percent of the funds they handle, with a minimum of $1,000 and generally a maximum of $500,000, or $1,000,000 for plans holding employer securities. A plan official handling $3,000,000 needs a $300,000 bond, while one handling $8,000,000 is capped at $500,000.

ERISA and Rollover Advice

Advisers most often meet ERISA when a client leaves a job and asks what to do with a 401(k). Recommending a rollover moves money from an ERISA-protected plan, often with institutional pricing, into an IRA that may carry higher costs and that pays the adviser.

The Department of Labor’s prohibited transaction exemption 2020-02 allows advisers to receive compensation for rollover advice if they act in the client’s best interest, charge reasonable compensation, make no misleading statements and document why the rollover suits the client. Broker-dealers must also meet Regulation Best Interest, and investment advisers their fiduciary duty under the Advisers Act.

A sound process compares fees, investment options, services, withdrawal rules and creditor protection between the plan and the IRA. Our article on what a 401(k) is explains the withdrawal and rollover rules that feed into that comparison.

Enforcement and Penalties

The Department of Labor’s Employee Benefits Security Administration investigates plans, and participants can sue fiduciaries in federal court to recover losses or enforce their rights. Fiduciaries found in breach must restore losses and give back any profits made through misuse of plan assets.

The Department of Labor can also add a civil penalty of 20 percent of the amount recovered in a settlement or court order for a fiduciary breach. Willful violations of ERISA’s reporting and disclosure rules can lead to criminal penalties.

ERISA generally preempts state laws that relate to employee benefit plans, so plan rules are largely uniform nationwide. State securities laws and the regulators who enforce them still apply to the advisers who serve those plans.

The Memory Aid

Remember “LPDD” for the four duties: Loyalty, Prudence, Diversification and Documents, meaning following the plan documents.

For fiduciary roles, remember “21 advises, 38 decides, 16 administers”. A 3(21) adviser recommends, a 3(38) manager makes the investment decisions, and a 3(16) administrator runs the plan.

For 404(c), remember “three and four”: at least three diversified options, and the ability to switch at least four times a year.

Exam Traps to Avoid

The first trap is assuming ERISA requires employers to offer a retirement plan. It sets standards only for plans that employers choose to establish.

The second trap is treating government plans as ERISA plans. Federal, state and local government plans and most church plans are exempt.

The third trap is believing 404(c) protects fiduciaries from every loss. It covers losses from participants’ own choices, not the fiduciary’s choice of investments for the menu. The fourth trap is assuming a prohibited transaction is allowed because the price was fair; the conflict itself is prohibited unless an exemption applies.

A Client Scenario

The owner of a 60-employee engineering firm asks an investment adviser representative to review its 401(k). The plan’s funds carry an average expense ratio of 0.95 percent, nobody has reviewed the menu in six years, and the owner’s brother-in-law’s firm provides recordkeeping without any written fee disclosure.

The adviser explains that the owner, as plan sponsor, is a fiduciary personally liable for a prudent process. The adviser recommends obtaining the 408(b)(2) fee disclosure, benchmarking costs against similar plans, and documenting a formal investment review with an investment policy statement.

The adviser also notes that a relative’s firm is a party in interest, so the arrangement must fit within the exemption for reasonable compensation for necessary services. Finally, the adviser explains the choice between a 3(21) role, where the owner keeps the final decision, and a 3(38) role, where the adviser takes discretion over the menu, so the owner can decide how much responsibility to hand over.

The Dictionary as a Video Library

The FRC dictionary is a study tool, not just a glossary. Every entry pairs a written explanation with deep-dive video, on-page quizzes and interactive flash cards, so you can read a concept, watch it explained and test yourself in one place.

Rules are covered in the same depth: open a rule such as Regulation Best Interest and you will find the full explanation alongside video walk-throughs of how it applies in practice. Use the FRC dictionary to open every term in this article as its own explanation, video and quiz.

Practice Questions to Test Yourself

Question one: Which of the following is generally exempt from ERISA: a corporate 401(k), a union pension plan or a state teachers’ retirement plan? The state teachers’ retirement plan, because government plans are exempt from ERISA.

Question two: An investment manager has discretion to add and remove funds on a 401(k) menu. Under which section is it acting? Section 3(38), which defines an investment manager with discretionary authority over plan assets.

Question three: A 401(k) offers two investment options and allows changes once a year. Can the fiduciary rely on 404(c) protection? No, 404(c) requires at least three diversified options with materially different risk and return and the ability to change investments at least quarterly.

Question four: A plan official handles $2,500,000 of plan assets. What is the minimum fidelity bond required? $250,000, which is 10 percent of the funds handled and within the $500,000 general maximum.

Question five: Which agency enforces ERISA’s fiduciary standards for retirement plans? The Department of Labor, through the Employee Benefits Security Administration.

Turn ERISA Knowledge Into Career Evidence

Plan sponsors are increasingly looking for advisers who understand fiduciary process, and retirement plan advisory, plan consulting and benefits compliance roles all reward ERISA knowledge. FRC’s Digital Profile shows employers the courses you are actively studying and the progress you have earned through assessed learning, verified by FRC, and a QR code on your resume takes them straight to it.

The FRC Video Resume lets a hiring manager hear you before the interview. Explaining clearly how a 3(21) and a 3(38) role differ is the kind of precision that sets a candidate apart.

Candidates returning to the exam should note that the wait after a third failure drops from 180 days to 60 days for exam windows opened on or after January 4, 2027, as explained in our article on the Series 65 retake rule change.

Related Questions

Continue with What Is a 401(k)? for the plan most ERISA questions involve, and Defined Benefit vs Defined Contribution Plans for how ERISA treats each plan type.

For the accounts that sit outside ERISA, read Traditional IRA vs Roth IRA, and for the conduct rules that apply to firms, see our FINRA rules quick reference on duties and conflicts.

Key Points to Retain

ERISA is the 1974 federal law that sets standards for private-sector employee benefit plans, covering participation, vesting, funding, disclosure and fiduciary conduct. Government plans and most church plans are exempt, IRAs are generally not ERISA plans, and Title IV created the PBGC to insure private defined benefit pensions.

Fiduciaries owe duties of loyalty, prudence, diversification and adherence to plan documents, and are personally liable for losses caused by a breach. Prohibited transactions with parties in interest are banned unless an exemption applies, 404(c) protects fiduciaries from losses caused by participants’ own choices, and everyone handling plan funds must be bonded for at least 10 percent of the funds handled.

For the exam’s structure and requirements, see the Series 65 dictionary entry, and for the role the exam leads to, read our guide to what an investment advisor representative is.