A pension plan is usually related to employment and the employer promises an employee a certain amount for retirement associated with that employee’s work. When you set up a pension plan with your employer, you make monthly contributions to the pension account until you retire.
Your pension plan payout depends on how long you worked for your employer and how much your salary is. When you retire, you can choose between a lump-sum payout or a monthly annuity payout.
- What is the Difference Between Retirement Plans and Pension Plans?
- What are Some Basic Types of Pension Plans?
- What are Some Other Basic Retirement Plans?
- What are Some Benefits Associated with Pensions?
- What are Some Benefits Associated with Retirement Plans?
- Do I Need a Lawyer for Help with Pensions or Investments?
While some retirement plans may be available through employers, it is usually one’s individual responsibility to contribute to a retirement plan. The biggest difference between pension plans and retirement plans are that pensions guarantee a given amount of monthly income in retirement and place the investment risk on your employer.
A retirement plans such as a 401k individual employees to choose their own retirement investments with no guaranteed minimum or maximum benefits.
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.
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.
Pensions may often be advantageous for several reasons. For instance, a person who has invested in a pension plan may have legal advantages in terms of issues like:
- Tax purposes: Pensions can have overall benefits for both the retired person as well as their employer.
- Insurance: Many pension plans include some for of insurance coverage. This is important, as retirees are usually either aged or disabled.
- Controlled Management: Pension plans help a person to avoid overspending. Rather than having access to all of their funds, pensions are dispersed periodically according to the plan terms.
- Through Employer: There are many different types of pension plans available for workers. These all differ according to factors such as the employer’s salary rate and length of employment. Thus, the worker can often choose a plan that would work best for them.
Retirement plans such as a 401k have many advantages for employees:
- Tax Benefits: All 401k contributions are pre-tax dollars being contributed.
- Financial Security: Employees have an opportunity to improve financial security in retirement.
- Earn compound Interest: You can earn compound interest overtime and make retirement savings grow
- Carry Over to New Employer: You can carry over any retirement plan to another employer and keep contributing.
Pension and retirement matters are sometimes complicated to handle. It is best if you handle these matters early on. You may wish to hire an employment lawyer if you need help understanding pension laws and how they work. Your attorney can help you review your pension options and can help you with your retirement plans.