Retirement plans defined: A lexicon of benefits options
Regardless of the kind of retirement plan your company offers, it pays to know what all your options are. Here are definitions of five basic kinds of retirement plans, as broken down by the nonprofit Employee Benefit Research Institute.
Note: There are lots of variations on these basic plans. Your retirement benefits provider can guide you toward the options most appropriate for your organization and employees.
Defined benefit plan
This is the traditional pension your grandfather had. A defined benefit plan is usually paid in the form of an annuity. The benefit is based on a formula, typically involving salary and length of service. Private-sector defined benefit pensions are usually financed entirely by the employer.
They’re not “portable”—that is, they don’t move with an employee from job to job.
Defined contribution plan
In contrast, a defined contribution plan doesn’t guarantee any retirement benefit. Most often, contributions from both the worker and the employer finance the plan.
The best-known kinds of defined contribution plans are the 401(k) and its cousin, the 403(b), both named after the part of the Internal Revenue Code that authorizes them. Defined contribution plans are now the most common kind of retirement benefit.
Defined contribution plans let workers control how the contributions are invested. That gives employees more control over the funds, but it also carries more risk because funds may rise and fall depending on investment market performance. Benefits can be “rolled over” into other investment vehicles when workers change jobs.
Cash balance plan
Cash balance plans combine elements of both defined benefit and defined contribution plans. However, they do so in a way that gives the employer a better projection of its future obligations. The employer usually contributes a defined amount each year, which guarantees that the account will grow by a fixed percentage annually.
A worker reaching retirement age can typically take the accrued amount either as a lump sum or an annuity. Cash balance plans have become less popular in recent years.
IRAs & Keogh plans
As a benefits administrator, you’re less likely to deal with these two kinds of retirement vehicles. However, your employees may hold retirement investments in them, which may factor into their retirement planning calculations.
- Individual retirement accounts: Individual retirement accounts (IRAs) allow a person to set aside and invest a contribution each year in an individual account. There are several different types of IRAs, and in recent years Congress has expanded them for nonretirement purposes (such as education). IRAs are typically used as a holding vehicle for money that is rolled over from another retirement plan upon job change, such as a 401(k).
- Keogh plans: Keogh plans are tax-deferred retirement accounts for self-employed workers or persons employed by unincorporated businesses.