Employee Benefit Trust: Definition & Purpose

Instructor: LEROY (Bill) RANDS

Bill has taught college undergraduate and MBA classes in finance, economics & management, 40 years of finance experience and has a MBA degree.

Companies provide a number of benefits to employees to be competitive. This lesson will go over one these benefits called an employee benefit trust (EBT) - a retirement program where stock or cash is put away for retirement purposes.

Employee Benefit Trust

Many employees are concerned about whether their retirement will be there when they want it. Are retirement funds secure?

Most larger companies sponsor plans to help employees prepare for retirement. Examples of retirement plans are:

  • an employee stock ownership program
  • a defined benefit retirement plan
  • a defined contribution retirement plan, like a 401K

An employee benefit trust is an investment plan where funds contributed by an employer and an employee are held in a trust. It usually applies to retirement plans because most other employee benefits are services that the employer pays as they are used. The employer is usually considered the grantor and the employees are the beneficiaries of the employee benefit trust.

ERISA Requirements

Company retirement programs have to comply with federal laws, specifically, they must be incompliance with ERISA, the Employee Retirement Income Security Act of 1974. This law governs basic questions like:

  • how long does an employee have to wait to participate in a plan? (usually a year)
  • how old do they need to be? (most require an employee to be 21 or older)
  • how long do they have to wait until they are vested in their retirement account? (usually at most 6 years).

ERISA maintains minimum standards that a company has to meet.

Operation of an Employee Benefit Trust

An employee benefit trust is organized by the company. A trustee is appointed who is the manager of the fund. Depending on the type of fund, there might also be fiduciaries who decide how the funds in the trust are invested. The fiduciary has personal liability if the funds are not managed in a reasonable manner or fraud occurs.

Say XYZ Corp has a 401K plan that's in the XYZ Retirement Plan Trust. Steve is the fiduciary of the trust; however, the 401K plan allows participants to choose how to invest their contributions. Steve directs which mutual funds and investments are available to the employees and provides a wide range of alternatives based on risk and return. The employees then direct where they want their contributions invested.

In Steve's case, the fiduciary responsibility has been limited by allowing employees to choose among a range of investment options. However, that fiduciary responsibility can be significant in the case of, say, a defined benefit program where the company contributes money toward employees' retirement and the fiduciary is solely responsible for directing the investment of the funds.

Retirement Plan

The company sponsoring a retirement or savings plan can either contribute cash or stock of the company to the plan. Contributions are made to the employee benefit trust where they are kept in trust for the individual participants. Depending on the type of plan, the employees may or not make contributions. The funds are held in trust until the employee retires and starts withdrawing from the account.

Say Ellen is in the 401K plan offered by ABC Inc. When she became eligible after one year of employment, ABC matched Ellen's contributions to her plan dollar for dollar up to 5% of her earnings. Ellen was automatically vested in her contributions but had to work for 5 years to be fully vested in the company's contributions. After 5 years, all the funds in the account belonged to Ellen and were held in the employee benefit trust until Ellen decides to retire.

Under ERISA, the company must not only meet the minimum standards but must ensure the money is held in trust for the employees. The company can change the plan or choose to stop making contributions, but the funds already contributed are untouchable and remain in the trust.

Services Provided

An employee benefit trust is set up by the sponsoring company, but they appoint an investment manager to do the actual investing.

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