Pension plans vary greatly in terms of the benefits that they provide and their structure. The two most common types of pension plans are the defined contribution or the money purchase plan and the defined benefit plan. Sometimes these two plans are combined and the combination is thus known as hybrid plans or combination plans.
Designed Benefit Pension Plans
The designed benefit pension plans are designed to provide a fixed amount of pension benefit after you retire from your job based on some formula. This formula, which his used to, calculate the pension benefits, depends upon various factors like the amount that you pay and years of your service. It is described in the documents of the pension plans that are provided to members. Members who avail this type of pension plans are advised annually about the pension benefit that they have earned up to that point.
The company mainly uses three types of formulae to determine the pension benefits of the member.
Flat benefit formulae- The annual pension benefits that you will get will be a fixed amount per year of your service. For example 50$ per month per year of service.
Final or best average earning formula- In this formula, the pension will adjust as per your wages. For each year of your service, this formula provides a specified percentage of your final earnings or average of your earnings over a specified period. For example, 2% of your average earnings over the best 6 years of earnings X year of service.
Career average-earning formula- In this, the annual pension benefit, which you will receive, is a fixed percentage of your annual earnings. For example-1.5% of your annual earnings.
Defined contribution pension plans.
This is also known as money purchase plan. In this, a fixed amount is regularly contributed for you. The money is placed by your name in an investment account. After you retire, these investments along with interest are used to buy pension. However, in this you will not have any idea about the amount of pension until you retire.
Some plans of this category allow employees to make their own investment choices. Whereas other require that the investments decision should be left with board of trustees or other senior people in the organization.
Ultimately, the pension benefit that you are going to receive after your retirement will depend upon the contributions made on your behalf or by you. It will also depend upon the return on the investments on the contributions made by you and the annuity factor.
Both defined contribution and the defined benefit plan are registered pension plans, but apart from them there are few pension plans that are not registered, these are Deferred profit sharing plan (DPSP), Employee stock purchase plan (ESPP), Individual pension plan (IPP). These do not generally follow the same rule that registered pension plans follows. These plans heavily depend upon the performance of the company in which you are working. Thus, it will be difficult for you to estimate the amount that you are going to receive post retirement.
Individual pension plan is mainly designed for people with higher incomes. This plan allows bigger tax-deductible contributions. Employee stock purchase plan allows an employee to buy the shares of the company at a lower price, less than what you pay at the stock market. Deferred profit sharing plan is a plan that the employers use to build retirement fund for its employees. The company also contributes a portion of its profits to these funds. However, an employee cannot put his own money in a DPSP.
Article Source: http://EzineArticles.com/3097760
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