Pension plans are often a key component of your employee’s benefits package from their perspective. But they can be costly for you.
Basically there are two types of pension plans:
- Defined benefit
- Defined contribution
Let’s expand on these plans!
Defined Benefit Pension
Now, defined benefit pension plans guarantee a certain level of monthly payments for an employee after they retire. These payments are based on factors such as the number of the years of service for the employee and their salary level. These payments are guaranteed regardless of the investment performance of any pension fund used to fund those payments. Over the last couple of decades in the US there has been a significant shift by employers away from offering these kind of plans due to the investment risk borne by the employer and the increasing longevity of retirees.
Defined Contribution Pension
Defined contribution pension plans allow an employee to contribute or withhold a certain amount of pre-tax earnings into a tax deferred savings account (typically a 401(k) plan but also including ESOPs). The amount of payments the employee will be able to enjoy in retirement is solely dependent upon the investment performance of the funds contributed. Often an employer will match some level of the employee’s contributions, since the employee is the one who bears the investment risk. The employee has greater flexibility in how their individual retirement funds are chosen, often being able to select from a menu of equity and bond mutual funds and determine the amount allocated to each fund selected.
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