There are different kinds of retirement plans for those looking to start with retirement investment. Under the Employee Retirement Income Security Act, these include the defined benefit plans and defined contribution plans:
Defined benefit plans These are investment plans that assure you of a fixed monthly benefit after your retirement. This may either be an exact sum like $50 per month, or the amount may be calculated with the help of a formula that takes into account factors like an individual’s service period and salary amount. For instance, the beneficiary may get, say, 2% of the salary, averaged for the last four years of work for the company. In almost all of these defined benefit plans, the benefits are protected by the Pension Benefit Guaranty Corporation, which gives federal insurance with certain limitations.
Defined contribution plans These are retirement investment plans where the retiree is not assured of a specific amount of post-retirement. Here, either the employer or the employee, or sometimes both, fund the beneficiary’s employment account at a fixed rate, like 4% of the annual salary. In general, these contributions are on behalf of the employee, who will receive it in their account. Also, the amount will be based on the number of contributions and the losses or gains in investment during this period added or subtracted from it. The amount that the employee receives after retirement will depend on the changes in investment made because this affects the value of the contribution.
Simplified Employee Pension (SEP) plan It is a no-fuss retirement investment plan where employers can contribute a tax-favored amount to the individual accounts of employees on a regular basis. A SEP plan requires only a few reporting or disclosure processes. For the employee to receive what the employer contributes, they should open an individual account with the company. The employer cannot set up an individual account for an employee anymore.
Profit sharing plan This plan is one where the employer can decide how much they want to contribute per year to the employee’s account. This is based on a series of formulas to determine the amount to be contributed.
401(k) plan A 401(k) retirement investment plan is, in actuality, a defined contribution plan. An employee can choose to have a part of their salary kept aside, which is called deferred payment, and this part is contributed to the plan before taxes. In certain cases, the employer will contribute the same amount as the deferred payment amount. There are limits to the amount that can be placed aside. An employee who chooses this is someone who takes control of the desired outcome and the method to get there.
Cash balance plan A cash balance plan is a defined plan benefit. Here, the amount that is eventually due to the employee is shown as an account balance, and the employee’s account is annually credited with pay credit and an interest credit. Pay credit is a certain percentage from the employer, and interest credit is a rate, either fixed or variable, associated with an index.
