Private Pension
How Much Should You Save For Your Pension?
Each and everyone of us would want to plan for our future. After years of slaving ourselves with work, don’t you think we deserve to catch a break when we finally reach our retirement age? This is why, we save up so we won’t have to worry how we will come by after retirement. In the US, baby boomers are expected to receive some kind of pension from the government. But since this won’t be enough to allow them to live a comfortable life after they retire, most invest in private pension plans to ensure their financial security. However, the question is, how much is enough when it comes to your pension? › Continue reading
American Private Sector Pension Plans
With the growing fear of public pensions being terminated due to the current financial difficulties faced by the US government, employees and company owners alike are turning to private sector pension plans to supplement their retirement program. This kind of pension plan offers its holders with complete financial freedom since no government intervention is involved.
The private pension sector covers two types of pension plans – defined contribution plans and defined benefit plans. Compared to public pension plans, private sector pension plans do not include annuities that are purchased for the insured assets or retirees. In addition, private pension also do not provide unallocated company insurance contracts. To understand private sector pension plans further, let us briefly discuss defined contribution plan and defined benefit plans.
Defined Contribution Plans
Defined contribution plans are available in many different plan types which include:
- Employee stock ownership plans (ESOPs)
- Money purchase plans
- Profit sharing plans
- Savings or thrift plans
When compared to defined benefit plans, this type of private pension plan generally define the contributions by the type of investment plan chosen by the plan holders or participants. Defined contribution plans have now become a dormant form of retirement plan in the private sector. It works by accruing benefits through the contributions made by the employer or the investment earnings added to the individual accounts of the key employees. The account of the participants will be used to offer retirement benefits via the acquisition of an annuity. Contributions are normally invested somewhere, like for instance in the stock market, and then the investment returns will either be added or deducted to the participant’s account.With a defined contribution plan, participants are the ones responsible for choosing the type of investments from which the funds for the retirement plan will be accrued and allocated. Money contributions for this type of private pension may come from employee matching contributions, employer contributions or via employee salary deferrals. A good example of defined contribution plans includes IRA (Individual Retirement Account) and profit sharing plans.
Defined Benefit Plans
In a defined benefit plan, employees will receive a specified lump sum upon retirement, or when they reach a particular age. The amount of annuity that the participant will receive greatly depends on employment earnings as well as the years they serve in the company. The pension plan sponsor, which is the employer in this case, will have to make regular contributions to hypothetical employee accounts, which will later be used to fund their retirement benefits.
No individual accounts are made for the participants in defined benefit plans. That means, investment risk strategy is shouldered solely by the sponsor. Meanwhile the amount of lump sum that the participant will get upon retirement will depend greatly on the accrued contributions, asset appreciation and investment earnings.
Personal Pension Plans
It is important to understand that risk will always be involved in any kind of pension plan, whether it be a public or private pension. That said, if you opt for a private sector pension plan you are just transferring the responsibility to someone else, other than the government. So if you are really concerned about saving for your retirement, would not it be better if you handle the contributions yourself? If you have full control over your retirement plan, you can add contributions and investments as you see fit. As long as you fund your retirement plan prudently, then you should not encounter financial problems in the future.
In conclusion, no matter what kind of pension plan you choose to help you save for your retirement, you have to weigh the risks involved before making a decision. Doing so will prevent the likeliness of encountering financial difficulties during the time that you need money the most.
Is A Cash Balance Plan Right For Me?
Another type of pension plan that is gaining a lot of attention recently is what is called as the ‘Cash Balance Plans’. What makes it different from other types of pension plans is that its pension holders can enjoy tax deductible benefits that are five times greater compared to 401(k) profit sharing plans.
It may seem that this kind of plan is just a newcomer in the market, since most might be hearing about it for the first time, but the truth is, cash balance plans has been around for about thirty years already. However, the reason why these plans failed to make it on the market in the past years is because their legality was questioned. Cash balance plans received a lot of heat during its infancy, to the point that their future became really bleak.
Fortunately, the legal uncertainty surrounding the cash balance plans have been resolved by the Pension Protection Act of 2006. Consequently, small and large business started to show renewed interest towards the much-maligned pension plan. But although the pension plan has successfully overcome the legal hurdles, many are still having doubts whether investing in one would be an informed decision.
Getting to Know the Cash Balance Plans
Before passing judgment, it would be best if you know a thing or two about cash balance plans. Doing so will allow you to decide whether this type of pension is right for you or not. First and foremost, let us define what this pension plan really is.
In context, a cash balance plans is a defined benefit plan where plan holders will receive cash balance credits to their retirement account. Interest credits are also added to their account balance, in which the rate of the interest credit will be clearly defined in the plan. This particular type of pension plan offers bigger tax deductibles. That being said, enrolling in a cash balance plan will surely be a valuable addition to your retirement plan.
What Makes it Different from Traditional Pension Plans
Compared to traditional pension plans, cash balance plans work a bit differently. Rather than accumulating a fixed monthly benefit, the plan promises a defined lump sum at retirement. When an employee enters a cash balance plan, the company where they are working will add contributions and interest credits to their account every year. Referred as the hypothetical accounts, there is no actual contribution that would be reflected on the employee’s account; however, the promised lump sum will be reflected during the time the employee retires from the company.
Who Are Eligible
Cash balance plans are ideal for businesses with consistent cash flows. This is a top requirement since the company have to make annual contributions to the employee’s hypothetical accounts. Businesses with inconsistent income stream are likely to have a hard time meeting their financial obligation, which can result to excised taxes and restricted benefits.
This pension plan can be used in conjunction with the 401(k) profit sharing plans for the company to take advantage of greater benefits for the key employees. However, one should also consider the workforce demographic make-up to be able to design the appropriate benefit formulas.
Conclusion
Before you decide entering a cash balance plan, it is highly advised to seek professional opinion to help you weigh its pros and cons. In addition to that, getting the assistance of a professional will help you tailor the right type of employee retirement plan that will suit your company.