Posted by QuickReadAbout.com Staff in A retirement plan is an arrangement to provide individuals with an income or pension during retirement when they are no longer earning a steady income from employment. Not all our lives that we work to earn a living and survive, you know. The time will come when we need to rest from work, not for a vacation, but to live the rest of the years enjoying the savings from previous years of hard work. Now, this makes the idea of retirement plans great. Through these plans, retirees will still be able to manage to keep the kind of lifestyle they want on their golden days.
Retirement plans may be established by employers, insurance companies, the government, or other institution such as employer association or trade unions. The Employee Retirement Income Security Act ,or ERISA, covers two types of retirement plans; defined benefit plans and defined contribution plans. Among the two types of retirement plans, there are also other types of retirement plans, which are referred to as hybrid plans, such as cash balance plans, combine features of both defined and defined contribution plans.
Here are the description of different types of retirement plans.
Defined Benefit Plan
A defined benefit plan promises a specific monthly payout at retirement, according to a fixed formula that usually depends on the member’s salary and the number of year’s membership in the plan. For example, 1 % of average salary for the last 5 years of employment for every year of service with an employer. The benefits in most traditional defined benefit plans are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC).
Defined Contribution Plan
On the other hand, defined contribution plan does not promise a specific amount of benefits at retirement. Instead, it will provide a payout at retirement that is dependent on the amount of money contributed to the employee’s individual account by the employee or employer or both, and the performance of the investment vehicles being utilized. The employee will then receive the balance in their account that is based on contributions, plus or minus investment gain or losses. The fluctuation of the value of the account is due to the changes in the value of the investments. 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans.
Hybrid Plans
A cash balance plan is a defined plan made by the employer with the help of consulting actuaries, a group of business professionals who deal with the financial impact of risk and uncertainty, to appear as if they were defined contribution plans. They have notional balances in hypothetical accounts where, normally, each year the plan administrator contributes an amount equal to a certain percentage of each participant’s salary; a second contribution, which is called an interest credit is also made. These are not actual contributions and further discussion is beyond the scope of this entry.0
Target Benefit plans are defined contribution plans made to match or look like defined benefit plans. This would only work if all actuarial assumptions are actually realized.