Your Company’s Bonus Plan Might Be Subject to ERISA. Here’s Why That Matters.

Overview

For decades, employers have relied on the “bonus plan exception” to design deferred compensation arrangements that avoid the onerous requirements of the Employee Retirement Income Security Act of 1974 (ERISA). By structuring these as incentive programs (i.e., deferred bonus plans) rather than retirement plans, employers can design flexible vesting schedules and implement “bad boy” forfeiture clauses.

However, recent litigation involving major financial institutions challenging this status quo is making its way through courts and government agencies. The central issue is whether a plan that provides payment at or near retirement constitutes a “pension plan” even though its stated purpose is incentive based. This note provides the historical framework, current legal challenge, and protective measures plan sponsors should consider for their plans.

I. How have incentive compensation plans been treated until now?

Historically, the regulatory framework has provided a fairly clear line of demarcation between plans intended to provide retirement income and those intended to reward performance.

• The Statutory Definition: Under Section 3(2)(A) of ERISA, a “pension plan” is defined as any plan that provides retirement income or results in a deferral of income to the termination of covered employment or beyond.
• The Bonus Plan Exception: Department of Labor (DOL) regulation 29 C.F.R. § 2510.3-2(c) clarifies that “bonus programs” providing payments for services performed are not pension plans unless such payments are systematically deferred to the termination of employment or beyond.
• The “Purpose vs. Effect” Standard: Until now, the prevailing view (reaffirmed by various DOL Advisory Opinions) was that if a plan’s purpose was to incentivize performance and retention, and payments were scheduled to occur during active employment, it remained exempt from ERISA even if some employees happened to receive their payments after retiring. The timing of these post-retirement payments was considered incidental rather than a systematic deferral.

II. Recent Legal Challenges

A. Why is this being challenged now?

The “bonus” label has come under fire due to an expanded interpretation of what constitutes systematic deferral of income.

• The “Surrounding Circumstances” Argument: Plaintiffs are shifting away from the “express terms” of the plan and focusing on the “surrounding circumstances.” They argue that when a significant percentage of a plan’s participants receive their “bonus” payments after leaving the company, the plan is a pension plan.
• Post-Termination Vesting: Many plans include “vesting” requirements that continue to become satisfied post-termination. An employee who retires may continue “earning” their previously awarded bonuses. Participants argue this makes the plan a retirement vehicle subject to ERISA’s strict non-forfeiture rules which would prohibit forfeiture of the bonus.
• Challenging the DOL: In one of the recent court filings, Sheresky v. Morgan Stanley, the plaintiff challenged the validity of the DOL’s Advisory Opinion, claiming the agency overstepped its authority by applying a “purpose test” that contradicts the plain language of the ERISA statute, which violates federal administrative rulemaking procedures.

B. Who is involved?

• The Plaintiffs: Former employees and high-earning executives who were required to forfeit their “unvested” deferred compensation by switching to a competitor.
• The Defendants: Large financial institutions (including Morgan Stanley and Merrill Lynch) and other firms with long-term incentive plans.
• The Department of Labor: The Employee Benefits Security Administration (EBSA) recently issued Advisory Opinion 2025-03A, reaffirming the bonus exception. This advisory opinion is currently being challenged in federal court.

III. What are the potential consequences for employers?

Industry Groups like the U.S. Chamber of Commerce and the American Benefits Council have issued statements that an ERISA designation for bonus plans would dismantle executive incentive structures.

If an incentive compensation plan is deemed an ERISA pension plan, the legal and financial fallout for the employer is significant:

• Vesting Issues: ERISA generally prohibits forfeiture of vested benefits. “Bad boy” or “non-compete” clauses that cause cancellation of deferred bonuses would become unenforceable.
• Fiduciary Liability: Plan administrators would be held to ERISA’s “prudent person” fiduciary standard, opening the door to lawsuits over investment choices and unreasonable administrative fees.
• Reporting and Disclosure: Employers would be required to file annual Form 5500s, provide Summary Plan Descriptions (SPDs), and comply with strict participant notice requirements.
• Funding Requirements: Plans could be subject to ERISA’s rigorous funding and trust requirements.

IV. What should employers do now?

Employers should consider conducting a “stress test” of their current incentive arrangements to mitigate the risk of becoming subject to ERISA:

• Analyze Payment Data: Review the percentage of “bonus” payments actually made to active employees versus to former employees. This could indicate whether the plan falls into the “systematic deferral” dispute.
• Review Plan “Purpose” Language: Ensure plan documents explicitly state the plan’s purpose is to provide incentive compensation for current service, not retirement income. This indicates that the plan is intended to fall within the bonus plan exception, and could help to establish any post-retirement payment as incidental.
• Evaluate “Top Hat” Status: If a plan might be an ERISA pension plan, ensure that participation is limited to a “select group of management or highly compensated employees” and timely file the required top hat notice to qualify for the top hat exemption.  A top hat plan is exempt from most of ERISA’s substantive requirements.
• Shorten Deferral Periods: Consider the length of payment timelines and possibly restructure payouts so they occur within a fixed window (e.g., 3–5 years), rather than pegging them to retirement eligibility.

This communication is not intended to create or constitute, nor does it create or constitute, an attorney-client or any other legal relationship. No statement in this communication constitutes legal advice nor should any communication herein be construed, relied upon, or interpreted as legal advice. This communication is for general information purposes only regarding recent legal developments of interest, and is not a substitute for legal counsel on any subject matter. No reader should act or refrain from acting on the basis of any information included herein without seeking appropriate legal advice on the particular facts and circumstances affecting that reader. For more information, visit www.buchalter.com.