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Retirement Planning
Most retirement plans fall into one of two major categories:
- Defined Benefit Plans - Defined benefit plans require employers to pay a fixed annual amount to eligible employees during their retirement years. Because of the high costs to employers, defined benefit plans are few and far between today. The trend has been toward defined contribution plans, where employees assume a much greater responsibility for contributing to their retirement savings.
- Defined Contribution plans - These plans allow employers and employees to contribute a set amount or percentage of pay, and retirement benefits are based on the actual performance of the funds. Defined contribution plans give the employer better cost control as the contribution is defined. The amount an employee can contribute is based on a percentage of their salary up to a maximum amount defined by law.
Defined contribution plans can take many forms, including:
- 401(k) - 401(k) plans allow employees, often matched in whole or in part by their employers, to set aside a portion of their salary for retirement. Retirement benefits are not guaranteed, however, and while the sum at age 65 may be substantial, it can also be much less if the employee has made poor investment choices or the stock and bond markets have not performed as well as expected.
- SIMPLE Plans - This option for companies with 100 or fewer employees allows an employee to contribute a percentage of his or her salary up to a fixed maximum to an Individual Retirement Account (IRA). The employer may also make contributions on a fixed or matching basis. SIMPLE plans are easy to set up, require minimal paperwork, and have low administrative costs. Plus, employees retain their SIMPLE account even if they change jobs.
- Simplified Employee Pensions (SEPs) - Created with the small business owner in mind, SEPs allow employers to set up IRAs for themselves and their employees. The employer contributes a percentage of each employee's salary each year, up to a fixed maximum. SEPs have low administrative costs, and can even be started by those who are self-employed. Since the business owner can decide how much to contribute each year, this type of plan is often the answer for businesses that may want to adjust their contribution based on the health of the business.
- Payroll Deduction IRAs - This type of plan, which requires no employer contribution, is designed solely to help employees fund their Individual Retirement Accounts. Employers set up a payroll deduction system that allows employees to regularly contribute to their IRAs. Contributions are tax-deductible to the employee, just as they would be with traditional IRA contributions.