What Are the Different Types of Pension Plans and How Do They Work?

It is vital to prepare for retirement while you are working. Wondering how you will pay for retirement can require some thought though. The answer to any questions you have may lie in pension plans.

There are several types of pension plans that you can use to support your retirement in the future. In this article, we will walk through what these types of pension plans are and how you can decide which one is best for you. So, without further ado, let’s begin by breaking down what pension plans are.

What are Pension Plans?

Pension plans are retirement plans where employers contribute money on your behalf. An employee can access this money once they retire. This differs from a 401(k) as you usually contribute your own money from your paycheck for retirement in this plan.

The main reason individuals choose pension plans is that it guarantees them income in their retirement. Here are some types of pension plans that you can choose:

• Defined Benefit Plans

Defined benefit plans are popular as they require an employer to promise a fixed monthly rate for the rest of an employee’s life when they retire. This removes responsibility from an employee and instead holds the employer accountable. The monthly rate that an employee receives depends on a number of factors. These can include salary, age, and years of service.

• Defined Contribution Plans

This retirement plan has employers contributing a fixed amount into an account in your name that you can choose to invest. A 401(k) plan is the most common type of defined contribution plan.

How much you receive depends on the amount of money you contribute during your working years. As well as this, the amount depends on how well these investments perform. You can choose to receive this money as a lump sum, an ongoing income stream, or a combination of both these methods.

• Hybrid Plans

Hybrid retirement plans combine elements of detailed benefit plans and defined contribution plans. Employers will contribute to a personal account of yours that is in your name, but this retirement plan will also guarantee you a minimum level of benefits. With hybrid plans, it is often the case that you will have the final say when it comes to controlling investment options.

• Cash Balance Plans

Cash balance plans exist where the employer contributes an amount of money to your retirement account every year which will receive a guaranteed amount of interest. This balance will become available to an individual once they choose the retirement route. This can be given to them in a lump sum. It can also be converted to an annuity for lifetime income for a retiree.

• IRA – Individual Retirement Account

An IRA allows an employee to make contributions towards their retirement that are tax-deferred. There are several types of IRAs that you can choose from. A traditional IRA, however, enables an employee to make contributions that are either fully or partially deductible. Read more about IRAs here.

• Annuities

Annuities are contracts between an individual and an insurance company. By paying premiums to a company, they will invest them for you, and you will receive the interest either immediately or in the future. Annuities can be fixed, indexed, or variable, but they will you a lifetime income. It is important to note that fees can be high.

Choosing the Right Pension Plans for You

Determining which of the pension plans is right for you takes plenty of time and consideration. Financial security is a necessity for all people in their retirement. When looking at pension plans, choosing which one is best will depend on several factors.

Factors can include how much you contribute each month/year, how much risk you are willing to take with investments, and how much control you want to have. Once you decide which is most important to you, you can begin to start planning your financial future.

Whether you choose an employer-sponsored plan or you want the security of a pension, setting yourself up for retirement is key. Although retirement feels like a long time away, these are the years of your life to prepare for it. Choose a plan, start contributing, and invest in one of the many pension plans that exist today.