Retirement plans come in all shapes and sizes, but most plans fall into a few broad types. The following is a list of the major categories. I discuss the individual plans in detail later in the book.
Defined Benefit Plans
A defined benefit plan is a retirement arrangement in which your employer guarantees the benefit. These plans usually provide a benefit related to your salary — for example, 80 percent of the average of your three highest years of compensation.
Defined contribution plans
A defined contribution plan is a retirement arrangement in which your employer contributes based on corporate performance. In other words, if the company you work for doesn’t perform well one year, it isn’t required to contribute to your retirement plan that year. Profit sharing plans fall into this category.
401(k) plans
A 401(k) plan allows employees to contribute to the plan, on a tax-deferred basis, by authorizing their employer to reduce their salaries and contribute this reduction to the plan. Often, the employer matches a percentage of the employees’ contributions. These plans have become the most popular form of qualified retirement plans.
Other types of qualified retirement plans Many other forms of qualified retirement plans are available, and new plans are appearing all the time. Among other plans you may know of or participate in are:
- Section 457 plans, which cover government employees
and employees of non-religious, tax-exempt organizations.
- Tax deferred annuities, or Section 403(b) plans, which cover religious and charitable organizations, as well as not- for-profit organizations and educational organizations.
- SIMPLE plans, which are primarily for smaller employers.
- Simplified Employee Pensions (SEPs), which are employer-sponsored plans under which contributions are made to the employees’ individual retirement accounts. The SEP plans are for very small businesses, usually those with 1 to 3 employees. In addition, the self-employed who are incorporated can participate in SEP programs.
- Money purchase plans, cash balance plans, target benefit plans, or savings plans, each of which is similar to a defined contribution or defined benefit plan but also has unique characteristics.
- Keogh plans are for self-employed individuals who are not incorporated. Any self-employed person may start a Keogh account with money earned through self- employment.
Other Retirement Investments and Savings Programs
Most people use a three-point strategy to fund their retirement:
- Their company-sponsored qualified retirement plan: Those ERISA qualified plans are either the defined benefit plans described latter or the defined contribution plans described in other articles.
- Social Security: Social security provides retirement benefit by getting monthly checks with the amount adjusted every year for inflation. Social security is given by government to individuals who meet certain requirement like: must be over 62 years, should apply for the benefit, and must had satisfied with having at leas 10 years of substantial earnings
- Individual savings and investments: If the company you work for offers a 401(k) program for retirement savings, the best advice is to participate fully.
