What Is a Nondiscrimination Rule?

A nondiscrimination rule is a clause found in qualified retirement plans stating that all employees of a company must be eligible for the same benefits, no matter their position within the company. The rule keeps plans from being discriminatory toward highly-compensated employees and company executives. Nondiscrimination rules are required for a plan to be considered qualified under the Employee Retirement Income Security Act (ERISA)

Key Takeaways

  • A nondiscrimination rule is an ERISA-required clause of qualified retirement plans that mandate all eligible employees receive the same benefits.
  • These rules mean that everybody from the CEO to the janitor, assuming both are eligible for a 401(k) plan, receive the same investment options, employer match, and tax breaks.
  • A non-qualified retirement plan, which does not fall under ERISA guidelines or have tax benefits recognized by the IRS, may be discriminatory or selective in nature.

Understanding Nondiscrimination Rules

Nondiscrimination rules must be kept up even when retirement plans such as 401(k)s are amended or transferred to another trustee, according to ERISA guidelines. A company may offer non-qualified plans, meaning that contributions are not tax deductible, that are discriminatory or selective in nature, in addition to standard qualified plans.

An investment policy statement is recommended to serve as a guideline for investment decisions to be made. The statement may include comments on risk tolerance, investment philosophy, time horizons, asset classes and expectations regarding rates of return.

ERISA has requirements for vesting options as well. Plan benefits may require a vesting period before employees earn the right to the benefit if they leave the company. ERISA regulations limit the length of such a vesting period to a reasonable schedule.

Not all employer plans are subject to ERISA. For example, government retirement plans are exempt from ERISA. IRAs are not subject to ERISA because an individual retirement account (IRA) is not considered an employer plan. Also, nonqualified plans, which do not qualify for tax-deductible contributions, are not subject to ERISA. 

For small businesses, a Simplified Employee Pension plan is basically an IRA set up by an employer so that it can contribute to employee retirement savings. Typically, these plans are not subject to ERISA regulations.

ERISA History

ERISA was enacted in 1974 to protect the rights of employees under retirement plans offered by their employers. In particular, this set of laws was put into place to address irregularities in the administration of certain large pension plans. In addition to its nondiscrimination rules stipulating that all plan participants must be treated equally, ERISA safeguards retirement funds from employer mismanagement.

The plan's trustee must manage plan assets and make decisions in the best interests of the plan participants. The trustee cannot sell assets to the plan or earn commissions from plan investments. Also, plan assets must be kept separate from company assets. As for investment options, fiduciaries for the plan must follow the Prudent Investor Rule discussed in the Handling Client Funds section.