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GLOSSARY: Retirement savings (retirement
plan)
(retirement plan definition)
 A
retirement plan is an arrangement to provide people with an income, or
pension, during retirement, when they are no longer earning a steady
income from employment. Retirement plans may be set up by employers,
insurance companies, the government or other institutions such as
employer associations or trade unions. Retirement plans are more
commonly known as pension schemes in the UK and Ireland and
superannuation plans in Australia.
Types of retirement plans
Retirement plans may be classified as defined benefit or defined
contribution according to how the benefits are determined. A defined
benefit plan guarantees a certain payout at retirement, according to a
fixed formula which usually depends on the member's salary and the
number of years' membership in the plan. A defined contribution plan
will provide a payout at retirement that is dependent upon the amount of
money contributed and the performance of the investment vehicles
utilized.
Some types of retirement plans, such as cash balance plans, combine
features of both defined benefit and defined contribution plans. They
are often referred to as hybrid plans.
Defined contribution plans
In a defined contribution plan, contributions are paid into an
individual account for each member. The contributions are invested, for
example in the stock market, and the returns on the investment (which
may be positive or negative) are credited to the individual's account.
On retirement, the member's account is used to provide retirement
benefits, often through the purchase of an annuity which provides a
regular income. Defined contribution plans have become more widespread
all over the world in recent years, and are now the dominant form of
plan in the private sector in many countries. For example, the number of
DB plans in the US has been steadily declining, as more and more
employers see the large pension contributions as a large expense that
they can avoid by disbanding the plan and instead offering a defined
contribution plan.
Examples of defined contribution plans in the USA include Individual
Retirement Accounts (IRAs) and 401(k) plans. In such plans, the employee
is responsible, to one degree or another, for selecting the types of
investments toward which the funds in the retirement plan are allocated.
This may range from choosing one of a small number of pre-determined
mutual funds to selecting individual stocks or other securities. Most
self-directed retirement plans are characterized by certain tax
advantages, and some provide for a portion of the employee's
contributions to be matched by the employer. In exchange, the funds in
such plans may not be withdrawn by the investor prior to reaching a
certain age.
Defined benefit plans
Traditionally, retirement plans have been administered by institutions
which exist specifically for that purpose, by large businesses, or, for
government workers, by the government itself. A traditional form of
defined benefit plan is the final salary plan, under which the pension
paid is equal to the number of years worked, multiplied by the member's
salary at retirement, multiplied by a factor known as the accrual rate.
The final accrued amount is available as a monthly pension or a lump
sum.
In addition, many countries offer state-sponsored retirement benefits,
beyond those provided by employers, which are funded by payroll or other
taxes. In the U.S., this is one role of Social Security.
Defined benefit plans may be either funded or unfunded. In a funded
plan, contributions from the employer, and sometimes also from plan
members, are invested in a fund towards meeting the benefits. The future
returns on the investments, and the future benefits to be paid, are not
known in advance, so there is no guarantee that a given level of
contributions will be enough to meet the benefits. Typically, the
contributions to be paid are regularly reviewed in a valuation of the
plan's assets and liabilities, carried out by an actuary. In many
countries, such as the USA, the UK and Australia, most private defined
benefit plans are funded, because governments there provide tax
incentives to funded plans.
In an unfunded plan, no funds are set aside. The benefits to be paid are
met immediately by contributions to the plan. Most government run
retirement plans, such as the social security system in the USA and most
European countries, are unfunded, with benefits being paid directly out
of current taxes and social security contributions. In some countries,
such as Germany, Austria and Sweden, company run retirement plans are
often unfunded.
Hybrid plans
A cash balance plan is a defined benefit plan made by the employer, with
the help (some critics say the connivance) of consulting actuaries (like
Kwasha Lipton, whom it is said created the cash balance plan) to appear
as if they were defined contribution plans. They have notional balances
in hypothetical accounts where, typically, each year the plan
administrator will contribute an amount equal to a certain percentage of
each participant's salary; a second contribution, called interest
credit, is made as well. These are not actual contributions and further
discussion is beyond the scope of this entry suffice it to say that
there is currently much controversy.
Target Benefit plans are defined contribution plans made to match (or
look like) defined benefit plans. This would only work if all actuarial
assumptions are actually realized.
Contrasting types of retirement plans
Advocates of defined contribution plans point out that each employee has
the ability to tailor the investment portfolio to his or her individual
needs and financial situation, including the choice of how much to
contribute, if anything at all. However, others state that these
apparent advantages could also hinder some workers who might not possess
the financial savvy to choose the correct investment vehicles or have
the discipline to voluntarily contribute money to retirement accounts.
This debate parallels the discussion currently going on in the U.S.,
where many Republican leaders favor transforming the Social Security
system, at least in part, to a self-directed investment plan.
Wikipedia information about
retirement plan
http://en.wikipedia.org/wiki/Retirement_plans
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