What Is a Pension? Types of Plans and Taxation

Introduction to Pension Plans

• Pension Plan Definition: A retirement savings benefit provided by employers.
• Employer Contributions: Regular contributions to a fund for employee retirement payments.
• Types: Defined-benefit and defined-contribution plans.
• Current Trends: Decline in traditional plans, shift towards defined-contribution plans like 401(k).

Key Characteristics

• Defined-Benefit Plans:
  • Guarantees a set monthly payment or lump sum upon retirement.
  • Employer-funded, with specified retirement income.
• Defined-Contribution Plans:
  • Employee contributions, possibly matched by employers.
  • Benefits depend on investment performance.
  • Examples: 401(k) and 403(b) plans.

Understanding Pension Plans

• Employer and Employee Contributions:
  • Employer contributions are generally required; employees may contribute.
  • Contributions deducted pre-tax.
• Complexity and Costs:
  • More complex and costly than other plans.
  • Excise taxes may apply for non-compliance in contributions.

Types of Pension Plans

• Defined-Benefit Plan:
  • Employer liability for fixed payments.
  • Historical prevalence from the 1870s.
• Defined-Contribution Plan:
  • Employees contribute, with employer matches possible.
  • Liability ends with total contributions.

Variations

• Pay-As-You-Go Plans:
  • Funded primarily by employee.
  • Similar to 401(k) without company match.
• ERISA and Fiduciary Responsibilities:
  • Federal law protecting retirement assets.
  • Information and guidelines required for fiduciaries.

Vesting and Taxation

• Vesting:
  • Defined-benefit plans: automatic or spread over years.
  • Defined-contribution plans: Contributions are fully vested upon payment.
• Taxation:
  • Qualified plans offer tax advantages.
  • Taxes deferred until withdrawal.

Modified Pension Plans

• Freezing Benefits: Stops accrual of additional benefits.
• Pension Funds: Pooled employer contributions managed by professionals.

Comparison: Pension Plans vs. 401(k)

• Employer vs. Employee Funding
• Risk and Control Variations
• Portability: 401(k) is portable, pensions require tracking.

Withdrawal Options

• Monthly Annuity vs. Lump Sum
  • Annuity offers lifetime payments.
  • Lump sum can be invested or rolled over.

Decision Factors

• Age, Health, Financial Situation
• Risk Tolerance and Estate Planning

Conclusion

• Pension Plan Suitability: Best for those desiring guaranteed benefits.
• Eligibility: Often requires meeting vesting requirements with specific employers.