A retirement plan, such as an IRA, 410(k), pension, annuity, or Social Security, is a financial account or agreement that provides monetary benefits after a person retires or reaches a certain age. Retirement plans fall into a few categories, including government-sponsored plans, employer-sponsored plans and personal plans.
The most common government retirement plan is Social Security, which pays benefits to retirees, their spouses, widows and children, and the disabled. For many people, Social Security is the largest source of their retirement income. There are also other types government retirement plans offered by federal, state and local governments to retired government employees.
Many people retire with employer plans. Generally speaking, there are two types of employer-sponsored retirement plans: qualified and non-qualified.
A qualified retirement plan meets certain tax and employee-benefit laws. Typically, there are tax benefits to a qualified plan. Often the taxes are deferred on contributions and earnings; the recipient, therefore, does not pay income tax until he or she withdraws the funds.
A qualified retirement plan that is created and managed by an employer falls under the umbrella of the Employee Retirement Income Security Act (ERISA). Employers must provide eligible employees with several documents (or at least have them available) for review. One document is the Summary Plan Description (SPD).
Qualified plans must undergo annual auditing to ensure highly compensated employees do not over contribute compared to other employees. Employers generally have fiduciary responsibility to make sure investments are reasonable and plan guidelines are followed.
A non-qualified plan does not have to meet the same legal requirements to qualify for tax benefits. This plan type could be provided to highly compensated employees in addition to a qualified plan.
Although ERISA governs qualified retirement plans, there is no law that requires employers to provide or contribute to company-organized retirement plans.
Many companies, however, choose to offer retirement plans because they offer tax benefits to both the employee and the employer. In time of low unemployment, a good pension plan can also give an employer a competitive advantage.
There are a number of types of plans, including pensions, which carry a promise that employees receive regular payments and are usually calculated based on the employee’s salary and the length of service with the company, usually upon retirement. There are also Employee Stock Ownership Plans (ESOP), which allow a company to contribute some of its corporate stock to employees, who become the stock’s owners, and 401(k)s, which is a type of deferred-compensation plan that allows employees to contribute a part of their earnings to a savings or investment account. Employers often match a percentage of employee contribution. The employee does not pay tax on contributions up front, but does pay tax when withdrawing money. Withdrawals may begin as early as age 59 1/2, but must begin after the individual turns 70 1/2.