Is My Severance Plan Subject To ERISA Or Section 409A?

• Published date: 23 November 2022
• Subject Matter: Employment and HR, Retirement, Superannuation & Pensions, Employee Benefits & Compensation
• Law Firm: Ice Miller LLP
• Author: Mr Gary Blachman

Recent volatility in the job market has caused many employers to implement reductions in force and employee lay-off programs. In order to reduce the economic consequences of an unanticipated job loss and mitigate the negative employee relations issues that can result from downsizing, many employers will offer those employees who are involuntarily dismissed a severance package or separation pay.

The primary benefit of severance pay is that the terminated employee receives a portion of their salary for a specified period of time. A common severance pay amount is two weeks of compensation. For executives, it is common to pay the executive one month of salary for each year the employee has worked for the company. In some cases, such as with senior level executives, the severance pay can exceed what the employee would have received in salary had they remained at the company.

Many severance arrangements are not formalized and simply consist of continuation pay for a specified period of time following termination of employment. Some employers prepare written policies or even adopt a formal severance plan with specific rules for participation and benefits. In both instances, employers should be aware of the various compliance issues that may have been overlooked and to avoid costly and unforeseen penalties if the severance arrangement is covered by the Employee Retirement Income Security Act ("ERISA") or Internal Revenue Code Section 409A.

ERISA and Severance Plans

A formal, or informal, severance plan may be governed by ERISA. While most employers are aware of ERISA's application to retirement plans and group health plans, many are surprised to learn that some severance arrangements are considered "welfare plans" under ERISA and, are therefore, subject to ERISA's reporting and disclosure requirements, as well as the rules for processing and determining claims. If the severance plan is subject to Section 3(1) of ERISA,¹ it will likely be required, among other things, to prepare and submit a completed Form 5500, make available a compliant Summary Plan Description to participants; and establish proper procedures for participants to appeal adverse claim determinations.

Because not every severance arrangement is covered by ERISA, many employers overlook its potential application when they are implementing or designing a severance plan. Although the application of ERISA is not a bad thing for employers, it can become a compliance concern if the employer is not aware of the various requirements that must be met if a severance plan is subject to ERISA.

How do Severance Plans Comply With ERISA?

Welfare plans are subject to significantly fewer ERISA...