Pension in the United States consist of the Social Security System.as well as various private Pension Plans offered by employers, insurance companies and trade unions. Private Pension plans are governed by various federal statutes and regulations, labor laws regarding the establishment(primarily ERISA). Pension law also incorporates judicial decisions with respect to those federal statutes and regulations. Pension Plans and benefits may also be subject to state laws.
What Is A Pension : –
A pension is a fund into which a sum of money is added during the employee’s employment years, and from which payments are drawn to support the person’s retirement from work in the form of periodic payments. A pension may be a “Defined Benefit Plan” where a fixed sum is paid regularly to a person, or a “Defined Contribution Plan” under which a fixed sum is invested and then becomes available at retirement age. Pensions should not be confused with “Severance Pay”, the former is usually paid in regular installments for life after retirement, while the latter is typically paid as a fixed amount after involuntary termination of employment prior to retirement.
Types Of Pensions : –
The Pensions can be : –
(i) Employment- based Pensions
(ii) Social And State Pension
(iii) Disability Pensions
(i) Employment- based Pensions : –
A Retirement Plan is an arrangement to provide people with an income during retirement, when they are no longer earning a steady income from employment. Often Retirement Plans require both the employer and employee to contribute money to a fund during their employment. It is a tax- deferred savings vehicle that draws for the tax- free accumulation of a fund for later use as a retirement income. Pension plans are, therefore, a form of “deferred Compensation”.
Pension may extend past the death of the employee himself/ herself continuing to be paid to the widow/ spouse.
(ii) Social And State Pensions : –
A basic state pension is a :Contribution Based” benefit. And depends on the individual’s contribution history. For example Social Security in the United States of America. Typically this fund requires payments throughout the citizen’s working life in order to qualify for benefits later on.Most Social plans, though, are means tested, such as Supplemental Security income in the United States.
(iii) Disability Pensions : –
Some Pension plans will provide for members in the event they suffer a Disability. This may take the form of early entry into a Retirement plan for a disabled member below the normal retirement age.
Classification Of Retirement Plans : –
Retirement Plans may be classified as : –
(i) Defined Benefit Plan : – It is a plan in which the benefit on retirement is determined by a set formula, rather than depending on investment returns. Government pensions such as Social Security in the United States is a type of Defined Benefit Plan.
The Benefit in this plan is determined by a formula that can incorporate the employee’s salary at retirement, years of employment, age at retirement , multiplied by a factor known as accrual rate.
Many Defined Benefit Plans include early retirement provisions to encourage employee to retire early, before the attainment of normaal retirement age(usually 65 years). Companies would rather hire younger employees at lower wages.
(ii) Defined Contribution Plan : –
In a Defined Contribution Plan, contributions are paid into individual account for each member. The contributions are invested , for example in the stock market and the returns on investment(ROI) , which may be [positive or negative, are credited to the individual’s account. On retirement, the member’s account is used to provide retirement benefits.
Defined Contribution Plans have become widespread all over the world in recent years, and are now the dominant form of plan in the private sector in many countries. The number of Defined Benefit Plans in the U.S. are steadily declining, as more and more employers see Pension contributions as a large expense avoidable by disbanding the Defined Benefit plan and instead offering a Defined Contribution Plan.
(iii) Hybrid And Cash Balance Plans : –
Hybrid Plan designs combine the features of Defined Benefit and Defined Contribution plan designs.
A Cash Balance Plan is a defined benefit Plan made to appear as if it were a Defined Contribution Plan. As with the Defined Benefit plans, investment risk in a Hybrid Plan s largely borne by the plan sponsor. As with the Defined Contribution designs, plan benefits are expressed in the terms of a notional account balance, and are usually paid as Cash Balances upon termination of employment. These features make them more portable than traditional Defined Benefit Plans and perhaps more attractive to a more highly mobile workforce.
SIMPLE IRA : –
A SIMPLE IRA is a type of Individual Retirement Account (IRA) that is provided by an employer . It is similar to a 401(K) but offers simplee and less costly administration rules. Like in 401(K), SIMPLE IRA is funded by a pre- tax salary reduction. However, contribution limits for SIMPLE IRA plans are lower than for most other types of employer provided retirement plans.
SEP IRA : –
A Simplified Employee Pension Individual Retirement Account or SEP IRA, is a variation of the IRA. SEP IRAs are adopted by business owners to provide retirement benefits for the business owners and their employees. Because SEP accounts are treated as IRAs, funds can be invested the same way as is the case for any other IRA.
Tax Advantages : –
Most Retirement Plans offer significant tax advantages. Most commonly the money contributed to the account is not taxed at the time of the contribution. The other significant advantage is that the assets in the plan are allowed to grow through investing without the taxpayer being taxed on the annual growth year by year. Once the money is withdrawn, it is taxed fully as income for the year of the withdrawl. But there are many restrictions on contributions, especia;llyt with 401(K) and Defined Benefit Plans.
Currently two types of plans, the Roth IRA and the Roth 401(K) offer tax advantages that are essentially reversed from most Retirement Plans. Contributions to Roth IRA and Roth 401(K) must be made with money that has been taxed as income. Withdrawals from the account, thereafter, are received by the the taxpayer tax-free.