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Employers pay severance benefits to terminated employees in a variety of different arrangements. Such benefits can be based on informal company practice, commitments in employment contracts, or benefits provided through a formal policy or written plan.
Some of these arrangements are not “plans” for purposes of ERISA, the federal pension law. For example, a payroll practice of paying employees one or two weeks of pay for each year of service upon termination of employment is not a “plan” for ERISA purposes. More formal arrangements involving an “ongoing administrative scheme” will be “plans” for ERISA purposes. There are no clear guidelines about what constitutes an “administrative scheme” other than a series of court decisions that deal with the specific facts and circumstances presented by particular severance arrangements. But, if your severance arrangement is in written form (including multiple employment contacts providing severance benefits) and involves employer discretion as to benefit amounts and employee eligibility, it is likely to be a “plan” for ERISA purposes. That can be a major compliance problem only if your severance plan also is a “pension plan” for ERISA purposes.
Fortunately, there are hard and fast guidelines under Department of Labor regulations that clearly outline how to structure a severance benefit arrangement so that it is not a pension plan. Your severance benefit arrangement will not be a pension plan if:
(1) The payment of benefits is not contingent on the employee’s retirement;
(2) The total amount of severance payments does not exceed twice the employee’s annual compensation during the year immediately before the employee’s termination of employment; and
(3) All benefit payments will be made within 24 months.
Many severance pay arrangements will satisfy these criteria and avoid the complications of being ERISA pension plans. Those complications include rules similar to those that apply to 401(k) and other retirement plans such as coverage, vesting, documentation and annual reporting requirements.
TAKEAWAYS
If you provide a severance benefit, never characterize it to employees as a supplemental retirement benefit. Also, modify your plan as necessary to satisfy the Department of Labor criteria set out above. And, bear in mind that your incentive compensation arrangements may also be subject to an “ERISA trap” (see “Incentive Compensation and the ERISA Trap” HERE).
Andrew S. Williams has practiced in the employee benefits and ERISA arena since ERISA was passed in 1974. He has been recognized by his peers through a survey conducted by Leading Lawyers Network as among the top 5 percent of Illinois lawyers in Small, Closely and Privately Held Business Law and Employee Benefit Law. He maintains a website, www.BenefitsLawGroupofChicago.com, with additional updates, commentary and analysis on benefits and employment topics.
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