Pensions Explained

Pensions Explained

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Pensions Explained

Pension plans are often offered by companies to employees as a feature of an available benefit package. The competitiveness of a company's benefit package, including the pension plan, may directly influence a person's desire to work for that corporation. If a company maintains an attractive benefit package, more individuals may seek employment at that company, increasing the pool of applicants from which an employer is able to select. Pension plans are extremely important, as they help to ensure that an individual has access to monies once he/she retires.

Once an individual retires, he/she will no longer maintain a regular income from employment, making it difficult for him/her to address existing financial obligations. Pension plans will continue to provide an individual with an "income" so he/she does not struggle to remain financially independent.

Background Defined Benefit Plans 

Defined benefit plans are pension plans in which an employer maintains the responsibility of financing an individual's account. A specified calculation will be utilized to determine the quantity of money that an employer must contribute to a certain plan. This calculation takes into account many different factors about said individual, including his/her estimated life expectancy and how long he/she has worked for the company.

Based upon the results of mathematical operations, an employer will be required to deposit a designated amount of money into the pension plan. There are numerous advantageous features associated with this type of pension plan, including early retirement provisions. When an individual is granted a defined benefit plan, he/she will be guaranteed pension payments for the rest of his/her life. Therefore, he/she does not heed to fear outliving his/her retirement fund. This form of pension plan is often attractive to employees because the bulk of financial responsibility falls on the employer.

Defined Contribution Plans

When an employee obtains a defined contribution plan, he/she acquires the responsibility of funding this retirement account. While employers are obligated to finance defined benefit plans, the savings that accrue in contribution plans depend upon the funds that an employee invests in his/her own account. In most cases, a specified percentage of an employee's income will be deducted from the payments that he/she receives and reserved in his/her account.

Over a period of time, the money in the account will steadily increase, providing an employee with a significant sum of money to be used upon retirement. In many cases, an employer will be required to contribute a designated amount of funds to the pension plans of his/her employers, though the amount will vary. For example, an employer may be obligated to match the contributions made by an employee. In recent years, defined contribution plans have become increasingly common and they are currently the most popular type of pension plan used in the United States.

State Pensions 

The most recognizable type of state pension in the United States is Social Security. Many people do not perceive this public assistance program to constitute a pension plan; however, like all other pension plans, this program provides financial assistance to individuals upon retirement.

Just as individuals contribute to their retirement accounts throughout their working lives, they also contribute to the Social Security system through taxes. An individual's Social Security number is used to monitor the contributions he/she makes to the Social Security system. Much like a retirement fund, when an individual is struggling (though this may not be due to retirement) he/she may receive assistance from the Social Security system.

Disability Pensions

If an individual suffers from an injury, serious illness, or crippling disability, his/her financial obligations will not disappear. He/she will still be required to pay his/her bills and address any responsibilities that he/she maintains. This may be extremely difficult for an individual who is suffering from an incapacitating condition, as they are often unable to continue working and may lose their source of income in their job outright.

In order to address this possibility, many countries have instated disability pensions in order to offer financial assistance to individuals who are no longer able to work. Most of these pension programs maintain strict guidelines and eligibility requirements. In the United States, the established disability pension program is known as Supplemental Security Income. If an individual is eligible for Supplemental Security IncomeKeogh Plans 

In most cases, an employer will establish pension plans for his/her employees regardless of the type of pension plan that is offered. However, if an individual is self-employed, he/she will be responsible for establishing his/her own pension plan. Accordingly, individuals who are self-employed should consider creating a Keogh plan.

A Keogh plan is a type of pension plan reserved for self-employed individuals, in which a specified portion of his/her income, usually 25%, is invested in an account. There are numerous rules and regulations governing the withdrawals made from a Keogh plan. An individual should become familiar with these rules before establishing an account, as failure to comply with the conditions of the plan may result in unfavorable penalty fees.

Federal Employees Retirement System

It is commonly known that the federal government provides its employees with attractive benefit packages. One of the most attractive features of the benefit packages generally offered by federal agencies is the Federal Employee Retirement System. The FERS employs numerous different types of savings and investment vehicles to ensure that retired federal civil service employees maintain access to essential funds upon retirement.

In most cases, there are three primary ways in which a civil service employee will receive finances once he/she retires. An individual who was employed by the federal government will receive Social Security Benefits. He/she will also have access to an established Thrift Savings Program. Perhaps the most beneficial aspect of the Federal Employee Retirement System is the annuity payments that a retiree will receive. This will ensure that a retired federal employee will be provided with income payments throughout the duration of his/her life.

Public Employees Retirement Systems

Like federal employees, public sector employees are usually granted appealing benefit packages. Public employees will benefit from the pension plans offered by the Public Employees Retirement System. The rules and regulations governing these systems vary a great deal from state to state. In most cases, the funds within an individual's pension plan will likewise increase in three ways. An employee will make contributions to his/her account with a portion of his/her income.

Generally, an employer will be required to make some type of contribution to an individual's account, though the extent of his/her contribution will be dependent upon the type of pension plan that is granted. Plus, a portion of an employee's savings will be invested in some form of investment vehicle; if invested responsibly, the funds will reflect investment returns. The profit from investments will usually constitute a large portion of the funds available in an individual's pension plan. These methods will help to ensure that a retiree has access to the necessary finances.

Pension Funds 

Retirement funds and pension plans are some of the most common incentives offered by employers in benefit packages. Employers often promise to provide their employees with continued access to monetary resources through pension funds. A pension fund is a collection or pool of assets used to finance pension plans for retired employees.

A company may choose to establish its own pension fund, or multiple companies may choose to collaborate on a shared pool of funds. Pension funds increase in numerous ways, including contributions from employers and employees. Assets from the pool are invested in stocks, bonds, or mutual funds in order to yield a profit for employers and employees. If a pension fund does not maintain the necessary finances to address the promised pension payments, an employer may experience legal repercussions. 

Effects of Early Retirement on Pensions

While the notion of retiring early is very appealing to most people, it is essential that an individual develop an adequate early retirement plan to ensure that he/she maintains the finances necessary to provide support throughout the duration of his/her post-retirement life. Failure to establish an effective plan may yield detrimental financial consequences for a retiree, as individuals often fail to consider the consequences of early retirement.

When an individual chooses to withdraw money from his/her retirement fund or pension plan before he/she has reached the specified age, he/she will be subject to penalty fees. These penalty fees will result in an retiree losing a relatively large portion of his/her savings. Another common problem that results from early retirement is that an individual has not adequate prepared to retire early, and therefore, his/her retirement fund will be emptied before he/she retires.

Employee Retirement Income Security Act

Pension plans and retirement funds are extremely important financial assets to individuals who wish to retire. Without these funds, an employee would not have the ability to retire, because he/she would not have the funds that are required to purchase essential and desired goods and services. Because of the importance of pension plans, it is necessary to have legislation that regulates these financial resources.

The Employee Retirement Income Security Act was established in order to govern the creation, maintenance, and distribution of pension plans. Although this legislation cannot forcibly require an employer to establish pension plans for employees, it can regulate the use of pension plans in the event that an employer chooses to create them. This federal act governs all aspects of pension plans, including who is eligible for coverage and the designated vesting period. 

Pension Benefit Guaranty Corporation

When the Employee Retirement Income Security Act was established, the necessity of pension plan insurance was realized. Before the creation of this legislation, numerous companies terminated pension plans, causing employees to lose the majority of their investments. As a result, many employees did not receive the funds they were counting on to support them.

The government acknowledges the need to provide employees with support, so that in the event that a company terminates its pension plans, employees are not left destitute when it is time for them to retire. In order to first address this, the Employee Retirement Income Security Act established the Pension Benefit Guaranty Corporation. The PBGC offers insurance on pension plans. Therefore, if a company terminates pensions plans, retirees will still be permitted to receive some funds that they are entitled to get through the Corporation. 


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