A pension plan is an employee benefit plan established or maintained by an employer or by an employee organization (such as a union), or both, that provides retirement income or defers income until termination of covered employment or beyond. There are a number of types of retirement plans, including the 401(k) plan and the traditional pension plan, known as a defined benefit plan.
Very few people working today in the private sector have the old-fashioned defined benefit pension plan. You may or, more likely, may not have noticed that over the past 25 years major corporations have gradually replaced their traditional defined benefit pension plans with a 401(k) defined contribution offering.
Defined benefit pension plans are the classic retirement pension plan that you did not give much thought to while working at a corporation because the company paid for it and you assumed you were entitled to it when you retired. The key word to remember here is benefit. Under this type of plan, at retirement, employees receive a monthly benefit check for the rest of their life. The amount of that check is based on a formula that factors in average compensation and years of service at the company. This is the type of plan people usually associate with happy, secure retirees and their spouses sitting in their rocking chairs on their front porches contentedly watching the world go by.
A defined contribution 401(k) plan on the other hand is the new savings vehicle of choice in corporate America. There is no requirement for the company to contribute to the plan, although some companies do offer to match a percentage of the employees’ 401(k) contributions. If your company does matching contributions, take advantage of it. It’s free money added to your individual account.
The shift to 401(k) accounts requires employees to make a conscious decision to save a portion of their salary, which is done on a before-tax basis (avoiding income taxes) and grows tax-free until you begin distributions. However, the 401(k) plan also requires you to make the investment decisions and manage the account.
Refers to various incentive plans introduced by businesses that provide direct or indirect payments to employees that depend on company’s profitability in addition to employees’ regular salary and bonuses. In publicly traded companies these plans typically amount to allocation of shares to employees.
The profit sharing plans are based on predetermined economic sharing rules that define the split of gains between the company as a principal and the employee as an agent.
Sometimes referred to as a Pension Plan, requires a fixed percentage of compensation to be contributed to each eligible employee, annually. These plans are for businesses of any size, or individuals with self-employment income, earned on either a full- or part-time basis. The maximum employer contribution to a Money Purchase Plan is the lesser of 25% of eligible compensation or $45,000 per employee.
Qualified and non-qualified retirement plans are created by employers with the intent of benefiting employees. The Employee Retirement Income Security Act (ERISA), enacted in 1974, defines qualified and non-qualified plans.
Qualified plans are designed to offer individuals added tax benefits on top of their regular retirement plans, such as IRAs. Employers deduct an allowable portion of pretax wages from the employees, and the contributions and the earnings then grow tax-deferred until withdrawal.
Non-qualified plans are those that are not eligible for tax-deferral benefits. Consequently, deducted contributions for non-qualified plans are taxed when income is recognized. This generally refers to when employees must pay income taxes on benefits associated with their employment
The main difference between the two plans is the tax treatment of deductions by employers, but there are other differences. A plan must meet several criteria to be considered qualified, including: