Simply Junior

There are many different retirement insurance plans available for retirees. Some are affiliated with your company; others are available through the federal government or private companies. Defined benefit plans are a type of pension plan that will benefit you throughout your retirement.

The defined benefit pension plan was the most common type of pension plan before 401k plans took over (which is a form of a defined contribution plan). Still, labor unions tend to still use this plan, as do self-employed individuals or business owners with a small amount of employees. These pension plans need a substantial amount of money being pumped into the investments, so more affluent workers are more likely to look into this as the best retirement insurance plan.

What is a defined benefit plan?

A defined benefit plan is an employer-sponsored retirement income plan that promises a specified monthly benefit at retirement. The promised amount could be a defined amount, say $200/month. However, it is more commonly based on a formula using factors such as salary history, your age, duration of employment, etc. The company controls all of the investment risk and portfolio management and is protected, with certain limitations, by federal insurance.

According to the IRS website, a defined benefit plan is a valuable and smart option to consider when making the choice between retirement plans.  Some of the reasons are

Employers can generally contribute more than to other types of plans Substantial benefits can be provided – even with early retirement Vesting can be immediate or spread out over a seven-year period Benefits are not dependent on asset returns

These plans are contributed only by your employer, but sometimes have stipulations that require contributions to be made by the employee as well.

Pros and Cons of Defined Benefit Plans

As in any retirement insurance plan, there are pros and cons to defined benefit plans based on different factors: income, age, how long you’ve been working with a company. Some pros of this plan are

Significant benefits possible in a relatively short period of time Employers can contribute (and deduct) more than under other retirement plans Plan provides a predictable benefit – Higher annual retirement benefits possible, up to $195,000 per year Plan can be used to promote certain business strategies by offering subsidized early retirement benefits Greater design flexibility

However, on the other side, some of the cons of a defined benefit plan are

The most costly type of plan The most administratively complex plan An excise tax applies if the minimum contribution requirement is not satisfied Annual return required Annual nondiscrimination testing required May delay vesting of participants’ accrued benefit

Keep in mind that defined benefit plans tend to need a steady stream of money going into them, so if you are living paycheck to paycheck, or are worried about how your retirement income will supplement how you are used to living, this might not be the retirement investment plan you should be looking for.

There are different types of retirement plans – government-sponsored plans, personal plans, annuities and employer-sponsored plans.

What’s the point of knowing all these plans?

This is because your employer’s retirement savings plan is important for your future financial security. You should understand how your plan works and what benefits you’ll receive. And it’s in your best interest to keep track of your retirement benefits too.

Let’s look at these different types of retirement plans.

Government-Sponsored Plans

Social Security plan is the best example in this category.

Personal Plans

Individual Retirement Agreement or IRA is the most well-known example. They can come in different types according to their tax treatments.

Annuities

These are contracts established with an insurance company. They can be fixed and variable annuities .

Employer-Sponsored Plans

2 types – qualified and non-qualified retirement plans.

Qualified Retirement Plans

These plans meet the Internal Revenue Code (IRC) requirements and the Employee Retirement Income Security Act of 1974 (ERISA) requirements.

They offer several tax benefits such as allowing employers to deduct annual allowable contributions for each participant of the plan; contributions and earnings on those contributions are tax-deferred until each participant withdraw them and each participant can even further defer some of the taxes through a transfer into a different type of IRA.

You can go for these qualified plans:

(A) Defined Benefit (DB) Plans

These are company retirement plans like pension plans, in which a retired employee receives a specific amount based on salary history and years of service, and in which the employer bears the investment risk.

The employee, the employer, or both may contribute to the plan.

Examples of DB plans:

1. Pensions

They’re a type of retirement plan that guarantees a specific amount to be paid out to the employee when he/she retires. The amount is calculated based on an employee’s salary, years of service and a fixed percentage rate.

The Pension Benefit Guarantee Corporation (PBGC), a federal agency, covers employer-sponsored pension plans.

Eligibility for the plan depends on a company’s policy. Some companies require their employees to serve for a certain period of time before they can become eligible for a pension plan. If an employee leaves the job, the pension plan stays with the previous employer.

2. Annuities

They’re retirement plans that have fixed monthly payments at the age of retirement. You can’t transfer the annuities into an IRA account, hence the amount is taxed as regular income the year you receive it.

(B) Defined Contribution (DC) Plans

These plans allow the employer and/or employee to make contributions, so that the final benefits depend on how much is in the account and the rate earned by the account’s investments. Each participant needs to set up his/her own individual account in the plan.

The government doesn’t guarantee a participant’s pension benefits. Instead, the plan allows employees to decide on the investment, based on the employer’s options.

Some examples of DC plans:

1. Profit Sharing Plan

It allows an employer each year to determine how much to contribute to the plan (out of profits or otherwise) in cash or employer stock. The plan contains a formula for allocating the annual contribution among the participants.

2. 401k Plan

An employee can make contributions from his/her paycheck before taxes are taken out. The contributions go into a 401k account, with the employee often choosing the investments based on options provided under the plan.

In some plans, the employer also makes contributions, matching the employee’s contributions up to a certain percentage.

3. Employee Stock Ownership Plan (ESOP)

The employer contributes shares of the company’s stock to employees in return for special tax benefits.

4.Stock bonus plan

It’s a type of profit sharing plan, where contributions are made in the form of company stock.

Non-qualified Retirement Plans

These plans don’t meet the IRC or ERISA requirements. Employers fund these plans. They’re more flexible but don’t have the tax benefits qualified plans have. Upon your retirement, your employer pay you the benefits (in the form of annuities) which are taxed as ordinary income tax, or in lump sum payments, which you can transfer into an IRA to defer taxes.

An example is the 457 plan.

This plan aims at state and local government employees of tax-exempt organizations. Your contributions and earnings are tax-deferred until you withdraw them.

Distributions start upon your retirement but you can also take distributions if you change jobs or if you’ve an emergency.You can choose to take distributions in one lump sum, in annual installments or as an annuity. Distributions are subject to ordinary income taxes and you can’t transfer the amounts into an IRA.