The first step to understanding your retirement benefits is to find out what kind
of retirement plan your employer has. There are two major types of plans, defined
benefit and defined contribution, which are described here and outlined in the table
below. Keep in mind that your employer may have more than one type of plan, and
may have different participation requirements for each.
Defined Benefit Plan
This type of plan, also known as the traditional pension plan, promises the participant
a specified monthly benefit at retirement. Often, the benefit is based on factors
such as your salary, your age, and the number of years you worked for the employer.
Defined Contribution Plan
In a defined contribution plan, the employee and/or the employer contribute to the
employee’s individual account under the plan. The employee often decides how his
or her account is invested. The amount in the account at distribution includes the
contributions and investment gains or losses, minus any investment and administrative
fees. The contributions and earnings are not taxed until distribution. The value
of the account will change based on the value and performance of the investments.
Let us review the table below to determine what type of retirement plan your employer
offers.
Characteristics Of Defined Benefit And Defined Contribution
Plans
Employer funded. Federal rules set amounts that employers must contribute to plans
in an effort to ensure that plans have enough money to pay benefits when due. There
are penalties for failing to meet these requirements.
There is no requirement that the employer contribute, except in SIMPLE and safe
harbor 401(k)s, money purchase plans, SIMPLE IRAs, and SEPs. The employer may have
to contribute in certain automatic enrollment 401(k) plans.
The employer may choose to match a portion of the employee's contributions or to
contribute without employee contributions. In some plans, employer contributions
may be in the form of employer stock.
Employee Contributions
Generally, employees do not contribute to these plans.
Many plans require the employee to contribute in order for an account to be established.
Managing the Investment
Plan officials manage the investment and the employer is responsible for ensuring
that the amount it has put in the plan plus investment earnings will be enough to
pay the promised benefit.
The employee often is responsible for managing the investment of his or her account,
choosing from investment options offered by the plan. In some plans, plan officials
are responsible for investing all the plan's assets.
Amount of Benefits Paid Upon Retirement
A promised benefit is based on a formula in the plan, often using a combination
of the employee's age, years worked for the employer, and/or salary.
The benefit depends on contributions made by the employee and/or the employer, performance
of the account's investments, and fees charged to the account.
Type of Retirement Benefit Payments
Traditionally, these plans pay the retiree monthly annuity payments that continue
for life. Plans may offer other payment options.
The retiree may transfer the account balance into an individual retirement account
(IRA) from which the retiree withdraws money, or may receive it as a lump sum payment.
Some plans also offer monthly payments through an annuity.
Guarantee of Benefits
The Federal Government, through the Pension Benefit Guaranty Corporation (PBGC),
guarantees some amount of benefits.
No Federal guarantee of benefits.
Leaving the Company Before Retirement Age
If an employee leaves after vesting in a benefit but before the plan's retirement
age, the benefit generally stays with the plan until the employee files a claim
for it at retirement. Some defined benefit plans offer early retirement options.
The employee may transfer the account balance to an individual retirement account
(IRA) or, in some cases, another employer plan, where it can continue to grow based
on investment earnings. The employee also may take the balance out of the plan,
but will owe taxes and possibly penalties, thus reducing retirement income. Plans
may cash out small accounts.
If you are still having trouble determining the type of plan available to you, we
suggest you ask your plan administrator, human resources office or employer for
information on what type of plan or plans you have at work. After you have determined
the type of plan available to you, we can review how you can participate in the
plan and begin to earn benefits.
