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The first step to understanding your retirement benefits is
to find out what kind of retirement plan your employer has. There are two
major types of plans, defined benefit and defined contribution, which are
described here and outlined in Table 1. Keep in mind that your employer may
have more than one type of plan, and may have different participation
requirements for each.
A defined benefit plan, funded by the employer, promises you a specific
monthly benefit at retirement. The plan may state this promised benefit as
an exact dollar amount, such as $100 per month at retirement. Or, more
often, it may calculate your benefit through a formula that includes factors
such as your salary, your age, and the number of years you worked at the
company. For example, your pension benefit might be equal to 1 percent of
your average salary for the last 5 years of employment times your total
years of service.
A defined contribution plan, on the other hand, does not promise you a
specific benefit amount at retirement. Instead, you and/or your employer
contribute money to your individual account in the plan. In many cases, you
are responsible for choosing how these contributions are invested, and
deciding how much to contribute from your paycheck through pretax
deductions. Your employer may add to your account, in some cases by matching
a certain percentage of your contributions. The value of your account
depends on how much is contributed and how well the investments perform. At
retirement, you receive the balance in your account, reflecting the
contributions, investment gains or losses, and any fees charged against your
account. The 401k plan is a popular type of defined contribution plan, and
there are three types of 401k plans: traditional,
SIMPLE 401k, and
Safe
Harbor 401k plans. The SIMPLE IRA plan, SEP, Employee Stock Ownership Plan
(ESOP), and profit-sharing plan are other examples of defined contribution
plans. (See explanations of the various types of plans in the Glossary at
the end).
Note
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Employers can choose whether to offer a retirement plan
to employees; Federal law does not require employers to offer or to
continue to offer a plan.
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The Pension Benefit Guaranty Corporation (PBGC)
guarantees payment of certain retirement benefits for participants in
most private defined benefit plans if the plan is terminated without
enough money to pay all of the promised benefits. The government does
not guarantee benefit payments for defined contribution plans. For more
information, see the PBGC’s Web site.
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Some hybrid plans – such as cash balance plans – contain
features of both types of plans described above. See the Glossary for
information on this type of plan.
Table 1 - Characteristics Of Defined Benefit And Defined Contribution
Plans
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Defined Benefit
plan |
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Defined Contribution Plan |
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Employer Contributions and/or Matching Contributions |
Employer funded.
Federal rules set amounts that employers must contribute to plans in
an effort to ensure that plans have enough money to pay benefits
when due. There are penalties for failing to meet these
requirements. |
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There is
no requirement that the employer contribute, except in the SIMPLE
401k and Safe Harbor 401ks, money purchase plans, SIMPLE IRA and
SEP plans.
The employer may choose to match a portion of the employee’s
contributions or to contribute without employee contributions. In
some plans, employer contributions may be in the form of employer
stock.
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Employee Contributions |
Generally, employees do not
contribute to these plans.
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Many
plans require the employee to contribute in order for an account to
be established.
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Managing the Investment |
Plan officials
manage the investment and the employer is responsible for ensuring
that the amount it has put in the plan plus investment earnings will
be enough to pay the promised benefit. |
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The
employee often is responsible for managing the investment of his or
her account, choosing from investment options offered by the plan.
In some plans, plan officials are responsible for investing all the
plan’s assets.
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Amount of Benefits Paid Upon Retirement |
A promised benefit
is based on a formula in the plan, often using a combination of the
employee’s age, years worked for the employer, and/or salary. |
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The
benefit depends on contributions made by the employee and/or the
employer, performance of the account’s investments, and fees charged
to the account.
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| Type
of Retirement Benefit Payments |
Traditionally, these
plans pay the retiree monthly annuity payments that continue for
life. Plans may offer other payment options. |
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The
retiree may transfer the account balance into an individual
retirement account (IRA) from which the retiree withdraws money, or
may receive it as a lump sum payment. Some plans also offer monthly
payments through an annuity.
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Guarantee of Benefits |
The Federal
government, through the Pension Benefit Guaranty Corporation (PBGC),
guarantees some amount of benefits.
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No
Federal guarantee of benefits. |
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Leaving the Company Before Retirement Age |
If an employee
leaves after vesting in a benefit but before the plan’s retirement
age, the benefit generally stays with the plan until the employee
files a claim for it at retirement. Some defined benefit plans offer
early retirement options. |
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The
employee may transfer the account balance to an individual
retirement account (IRA) or, in some cases, another employer plan,
where it can continue to grow based on investment earnings. The
employee also may take the balance out of the plan, but will owe
taxes and possibly penalties, thus reducing retirement income. Plans
may cash out small accounts.
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For more information or to have us answer any questions you may have,
please call 1-800-559-2900,
,
see our
contact Atlantic Financial
page,
or use this form to contact us:
Source
U.S. Department of Labor
(www.dol.gov)
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