Different Types of Pension Plans
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What Is the Difference Between Retirement Plans and Pension Plans?
A pension plan is usually related to employment: an employer promises an employee a certain amount for retirement associated with that employee’s work.
While some retirement plans may be available through employers, it is usually one’s individual responsibility to contribute to a retirement plan.
What Are Some Basic Types of Pension Plans?
There are several types of basic pension plans that are commonly offered by employers. Listed below are the most common types of pension plans:
- Defined Contribution Plan – under this plan, the company makes fixed contributions for an employee’s benefit. The funds grow in the plan due to contributions, earnings on investments, and sometimes from allocations of fired employees’ non-vested funds. The sum-total of funds available upon retirement (i.e., the retirement benefit) is not known.
- Defined Benefit Plan – this is plan based on the employee’s salary and length of employment. Specific monthly payments are offered when retirement begins. The plan uses a formula to calculate these payments so they are estimated to an employee before retirement begins. The employer must make the necessary contributions to the plan regardless of profits. An employee can often elect to receive a lump sum instead of monthly retirement benefits.
- 401(K) Plan – under this plan an employee must make contributions to his future retirement. However, employers frequently match these contributions up to a certain percentage to incentivize employee contributions. Often, an employee will be allowed to make a hardship withdrawal or borrow money from the plan.
- Cash Balance or Hybrid Plan – this plan essentially combines features of the defined benefit and the defined contribution plan.
What Are Some Other Basic Retirement Plans?
Often it is not sufficient to only have a work-related pension plan. Here is a summary of some basic retirement plans:
- Individual Retirement Account (IRA) – one may contribute funds to various financial instruments through this account. Taxes are paid only when money is withdrawn from the plan. Premature withdrawals before one’s retirement age may result in penalties.
- Roth IRA – this is a very flexible retirement plan from which one can make pre-retirement withdrawals without any penalties. However, contributions to Roth IRA are made after taxes, and therefore they don’t have to be taxed again when withdrawal occur.
- Roth 401(K) – this plan combines features of Roth IRA and 401(K) plans and is typically offered through the workplace. Some portion of an employee’s after-tax salary is used for contributions to the plan.
- SIMPLE IRA – this is similar to a 401(K): contributions are made from pre-tax salary, grow in the plan on the tax-deferred basis, and withdrawals occur at retirement.
- Rollover IRA – this gives employees an opportunity to consolidate 401(K) plans from several prior employees.
- SEP IRA – for self-employed people, this plan allows making contributions to retirement. Contributions are deducted from income taxes.
Seeking an Attorney’s Help
Pension and retirement plans can seem very complicated. An attorney can help you understand your options and can assess whether an employer has violated pension rules.
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Last Modified: 06-04-2014 10:05 AM PDT
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