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Before 401K Plans these plans were the most popular pension
plans in America. They still remain the basic retirement plan
for most large corporations.
All other types of retirement plans do not
have any limitation on the amount you can earn on your investments.
There is also the downside of not earning very much or even
losing money. The only guarantee in other retirement plans
would be the purchase of fixed annuities through insurance
companies, where the guarantee is based on the insurer's ability
to pay.
The Defined Benefit Plan guarantees a monthly income to the
plan participants at retirement regardless of the investment
results the plan obtains. The plan can be designed to pay
the cash equivalent of the future monthly income if a participant
terminates employment prior to or at retirement.
Because the company guarantees the benefit, these plans can
become very expensive. There are many kinds of formulas that
determine the guaranteed monthly income, and thus the eventual
cost. Overall the formula is limited to 100% of compensation,
up to a maximum monthly income at retirement of $13,333.
Defined Benefit Plans must assume a projected rate of return
on investments in order to compute the annual contribution.
An Actuary enrolled with the government must be employed to
make these pension calculations. Benefit Equity Plans employs
an actuary to certify all Defined Benefit formulas and calculations,
as required by law.
Generally, an interest rate is determined based on historical
rates for conservative investments, usually, 6% to 8%. If
the plans investment performance doesn't meet this assumed
rate the company must make up the difference. Likewise, if
the investment results exceed the assumed rate the contribution
will be adjusted down. The current years required contribution
cannot be determined until the investment results in combination
with certain employee payroll information is tallied.
These plans can be very beneficial to older employees that
haven't saved enough for retirement and need to make up for
lost time. Unlike all the other kinds of plans that limit
participants to a maximum contribution of $40,000 a year,
the Defined Benefit Plan doesn't impose a dollar limit. Therefore
depending on the age and salary of the participant it is possible
to contribute more than $40,000 a year. For example, if you
are around 60 years old it is possible to save over $100,000
a year through this type of plan.
The Employer establishes a contribution rate, generally between
1% and 25% of compensation. Once the contribution formula
is established, a formal amendment to the plan must be completed
to change the formula. In addition to the Employer contribution,
some plans allow for after tax participant contributions.
These plans can also be established without any employer contribution,
only after tax employee contributions. These programs are
referred to as Thrift Plans. Thrift Plans are not very popular
today because of the widespread use of pre-tax deferrals through
401K Plans.
These plans are used by employers that want to commit to
a fixed contribution formula. Money Purchase Plans can be
used in addition to or in combination with Profit Sharing
or 401(k) Plans. Although recent legislation has eliminated
the need for this type of plan.
This plan is a hybrid of Money Purchase Pension and Defined
Benefit Pension.
The individual annual addition cannot exceed
25% of compensation up to a dollar limit of $40,000. The formula
resembles a Defined Benefit Plan, whereby you determine what
the projected monthly income is for each participant and deposit
whatever it takes (not to exceed the limits above) to arrive
at the goal. Like a Defined Benefit plan this plan favors
employees closer to retirement age. Many times an age weighted
Profit Sharing plan can accomplish the same results, without
the mandatory annual contribution requirement.
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