Introduction to Pension Plans
While some people still stash cash under their mattresses for retirement, the majority know there are more springs than savings under there. When it comes to true savings, interest-bearing investments are the way to make money grow before you clock out for the last time. Because there are so many types of pension plans, it's important to understand the basics first before planning for your financial future.
Employer-Based Pension Plans
Although the terms "retirement plan" and "pension plan" are largely interchangeable, pension usually describes a plan based around employment, whether it's through your employer for or a work-related organization like a labor union. An employer, an employee or a combination of both can fund pensions. Some types of pension plans include:
- 401(k) plans
- Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) IRAs
- Simplified Employee Pension Plans (SEPs)
- Employee Stock Ownership Plan (ESOP) and Profit-Sharing Plans
- Conventional Defined-Benefit Pensions
Defined Benefit Plans
One of the two fundamental types of pensions, a defined-benefit plan spells out what you'll receive as a benefit after retirement. A monthly cash amount may be provided for, such as $250 a month, but a formula using factors such as your income, age and length of employment is more common.
For example, the pension benefit formula could be: one percent of your average salary for three years leading up to retirement, multiplied by the number of years you worked. The employer usually funds defined benefit plans.
Defined Contribution Plans
Defined contribution plans are more common than defined-benefit plans. They include the more commonly known workplace retirement plans, such as the 401(k) and its variations. You, your employer or both make contributions to this type of plan, creating an investment pool that's paid out at retirement.
Your retirement fund depends on the size and frequency of your contributions and whether your employer matches them or offers other savings options, such as profit-sharing or stock ownership plans.
Your Rights as a Pension Participant
Setting up a pension is voluntary for an employer, but the pensions themselves are subject to regulation after that step is taken. The Employee Retirement Income Security Act (ERISA) establishes standards and protection for pension plans.
As a pension participant, your access to information about your plan is guaranteed under ERISA. The person or company who runs the plan — called the administrator — gives you information on the most important aspects of your pension, such as financial information, rules unique to your plan, and how to make changes to your account.
The administrator is required to issue certain types of information automatically, such as annual summary reports. While other types of information, such as forms, are only available when you request them.