Types Of Retirement Plans

Today, there are many different types of retirement plans. We have individual plans, such as IRAs and Roth IRAs. We also have company plans, such as defined benefit (DB) plans and defined contribution (DC) plans. Many job seekers and even many employees are getting confused when comparing different types of pension plans. Here, we are going to give you a brief description of most common types of individual and company retirement/pension plans.

Individual Retirement Plan:

• Basic IRAs: An IRA is an individual retirement account, it is not started through a business. A taxpayer can contribute up to $4,000 per year in an IRA ($5,000 for year 2008, and after 2008, the contribution limit will adjust annually for inflation in $500 increments. For persons age 50 and over, the law provides an increase in the contribution limits applicable to IRAs). This contribution is tax deferred until an individual withdraws this money at retirement. Employees who also participate in employer-sponsored pension plans are limited in their ability to make tax-deductible contribution to their IRAs.
• Roth IRAs: Roth IRA was born on January 1, 1998, as a result of Taxpayer Relief Act of 1997. It is named after former Senator William V. Roth, Jr. A Roth IRA is similar to a traditional IRA except that the original contribution is not tax deductible. However, the investment earnings of Roth IRAs are not taxed when money is withdrawn at retirement. There are some income limits for Roth IRA contribution ($110,000 for singles, and $160,000 for married couples filing jointly).

Employer-Sponsored Retirement Plans:

• Defined Benefit Plans (DB): A defined benefit plan promises the participant a specific monthly benefit at retirement. This monthly benefit can be an exact dollar amount, or be calculated through a formula that considers a participants salary and years of service. Investment risk and portfolio management are entirely under the control of the company. There are restrictions on when and how you can withdraw these funds without penalties. DB plans were popular in 1950s and 1960s. However, since the passage of ERISA (Employee Retirement IncomeSecurity Act) in 1974, more and more employers have adopted defined contribution plans (DC).
• Defined Contribution Plans (DC): In DC plans, the employee or the employer (or both) contribute to the employee's individual account under the plan. These contributions generally are invested in mutual funds or, in some cases, the stock of your employer. As a result, the size of your retirement account is also determined by the investment performance of those mutual funds and appreciation in your company's share price. Balances accrue in DC plans belong to individual employees, who direct the investments and bear the risk of fluctuating assest returns.
  • 401(k) Plans: 401(k) is the most common type of employer-sponsored retirement plan. It is usually funded with your before-tax salary contributions and often matching contributions from your employer. Both the employer contributions (if any) and any growth in the 401(k) is tax-deferred until withdrawn. Your contribution limit is the lower of the maximum amount your employer permits or the government guidelines ($14,000 for 2005). The total contribution to your 401(k) account from all sources combined, including any employer matching or profit-sharing contributions, and any employee after-tax contributions is the lesser of 100% of compensation or $42,000 for year 2005.
  • Profit Sharing Plans: A Profit Sharing Plan is a retirement plan in which the contributions are made solely by the employer. The business owner has the flexibility to contribute and deduct between 0% and 25% of eligible participant's compensation up to a maximum each year.
  • SIMPLE Plans: Saving incentive match plan for employees is a type of pension plan that may be implemented by self-employed individuals or employers with 100 or fewer employees. It works similarly to a 401(k) plan. The maximum amount any qualified employee can contribute to a SIMPLE plan is $10,000 per year in 2005. The employer matches 100% of employee deferrals up to 3% of compensation or provides nonelective contributions up to 2% of compensation.
  • ESOP Plans: An Employee Stock Ownership Plan is a form of defined contribution plan in which the investments are primarily in employer stock.
  • Money Purchase Pension Plans: A Money Purchase Pension Plan is a retirement plan that requires fixed annual contributions from the employer to the employee's individual account.
  • SEPs: A simplified employee pension (SEP) is a very common retirement plan for self-employed individual and small businesses. A SEP is basically a group of IRAs, it allows employers to make contributions to their own IRA and to IRAs that their employees set up and control. Generally, you can make contributions of up to $42,000 a year or 25 percent of compensation, whichever is lower.