Retirement Plans: USA
Retirement Plan: U.S Private Industry Pensions are based upon the Employee Retirement Income Security Act of 1974 (ERISA), which is administered by the Department of Labor through the Employee Benefits Security Administration.
ERISA does not ask any employer to offer a pension plan to any employee of their organization but requires fixing minimum prescribed standards for those who offer pension plans to their employees. Moreover, the law also does not specify the rate of return on how much money a participant would get as a pension benefit after cessation of service.
Employee Retirement Income Security Act (ERISA)instructions to the administrators about the scheme of the pension plan
ERISA wants to know about plan administrators – the people who run plans and also communicate full facts of the pension plan to participants.
The plan administrator is legally obligated to provide the Summary Plan Description to plan participants free of charge.
The SPD explains in detail what the plan provides and how it works.
- how service time and benefits are calculated?
- when benefits become vested?
- when payments will be made and in what form?
- how to file a claim for benefits?
If any amendment in the Pension plan occurs, then administrators must inform plan participants about changes in the plan, either by providing them with a revised SPD or a separate document called a summary of material modifications. The materials will be provided free of charge to plan participants.
Each and every financial year, the plan administrator must provide plan participants with a copy of the plan’s summary annual report, free of charge. This summarizes the annual financial report that most pension plans must file with the Department of Labor on government Form 5500 or 5500-C/R.
Some people get retirement on income from an employer-sponsored defined benefit pension plan. Those Employers, who sponsor defined benefit pension plans are fully responsible for contributing money to the extent so that employees get committed benefits of the plan.
U.S. Department of Labor data shows a trend away from defined benefit plans and towards defined contribution plans, but there is no guarantee that the defined contribution account balance will be sufficient for your retirement.
Generally, in the def, annuities must be available for participants at retirement. If you have a pension plan which gives a lifetime annuity, it protects you from all life-period risk and the risk of surviving your assets. Defined contribution plans, such as 401(k) plans, typically in which there is no provision of the annuity.
To learn more about pensions and how they operate, visit the Department of Labor, Employee Benefits Security Administration.
Pension Plans:-
Some Employers Or Organizations offer a traditional ‘Defined Benefit Pension Plan’. In this category, the employer invests some money in order to provide a benefit to retirees based on their salary and the number of years they had worked for the employer.
Retirement Saving Plan, such as 401(k) plan, which does not give guarantee a fixed payment upon retirement. In this plan, the employee or employer or both contribute to the employee’s individual account. The employee shall have to bear the investment risk. Now we understand it broadly:-
401(k) Retirement Plan
Under a defined benefit pension plan 401(k) – it is a retirement saving plan of investment options which is offered by the employer that gives a right to an employee, choosing the investment options such as mutual funds or any other plan may be.
Those employees who choose a traditional 401(k) plan, have had the investment options – a portion of their pre-tax salary invested directly in the option or options they choose. This type of contribution and any earnings from the 401(k) investments do not come under tax till such type of investment is not withdrawn by the employee.
403(B) Retirement Plan
Under the defined contribution retirement plan 403(B) category, it is a tax-deferred retirement savings program that is available to employees of schools, certain non-profits organizations, and some members of the clergy.
Employer-Sponsored Plans
When any person joins his first Job OR any new organization, please check and see – whether your employer has enrolled you in a defined contribution retirement plan – 401(k) or 403(b), as mentioned above? Generally, some employers enrol new employees in such plans automatically as per the company’s policy but if you are not enrolled by the employer, you can enrol yourself also.
Focus on Fees
Each and every employee may have a choice of variations in mutual funds, index funds, and target-date funds. Fees and expenses differ from product to product and it can be too much expensive when you withdraw your funds. Even a minute difference in investment costs into large differences in returns over time. This difference can create a big impact on the saving for retirement.
Save on Autopilot
When you sign up, you have to choose the amount in which you wish to contribute from each paycheck and in which category, you want to invest the money. However, retirement savings can be increased, if you adopt yourself in the habit of paying pack checks first with these automatic payments.
Switching Jobs
When you switching a job from one company to another company, you must consider many financial issues, though, changes job from a higher paying job to any other. A determined financial plan can help you to organize your thoughts and make the transition less stressful.
Defined contribution plans, such as 401(k)s and 403(b)s, allow the following options:
- A Lump-Sum Distribution – You can withdraw 100% money from your account with a single payment. You will have to bear taxes and also pay tax penalties if you withdraw the money before the age of 59½.
- A Rollover to another Retirement Plan: You can also ask your past employer to transfer your account balance directly to your current employer’s plan if the employer agrees to accepts such transfers.
- Transfer of account balance to an individual retirement account (IRA): You can also ask your previous employer to transfer your account balance to an individual retirement account (IRA) so that invested money growth in the plan, to be continued for a long time and resultant, the employee can get more income for the smooth running of his life after retirement.
- No Alteration: If the employee is not interested to transfer their account balance into the present organization, he can do so to leave the account balance in a previous retirement plan.
Lifetime Income Calculator In Retirement Plan
Those employees who contribute in defined contribution plans such as 401(k) plans or savings plans can manage their retirement savings during employment and after retirement years.
As mentioned in an advance notice of proposed rulemaking (ANPRM), the Department of Labor is considering proposing a rule that the pension benefit statement must include the defined contributor’s account balance as a single sum along with an estimated lifetime income and the projected account balance at retirement.
For married employees, the statement must include joint and survival lifetime income benefits.
One can make presumption mentioned in the ANPRM, this calculator calculates pension in the form of monthly lifetime income based on both the contributor’s current account balance and on the estimated projected value of the account balance at retirement.
For these balances, the calculator develops two levels of lifetime payments: one for the life of the contributor (without survival benefit) and the second for the joint lives of the contributor and the spouse with a fifty percent survivor’s benefit for the spouse’s lifetime.
This calculator makes the calculation simple e.g. annual contributions and mid-year retirement. To rely on the views received in reply to the ANPRM, this calculator also provides a more precise calculation (e.g., monthly contributions, retirement in a specified month).
How the Calculator Works
This calculator also helps in estimating future contributions, investment earnings, and rate of inflation:
- Contributions to be increased continuously @3% per annum on the basis of current contribution till Retirement Age.
- Projected Investment returns are 7 per cent per year and this may be vary depending upon the nature of the scheme/bond.
- 3% inflation rate per year is used for discounting the projected account balance to the current dollar rate.
In converting the account balances into lifetime income streams, the calculator also calculates projected annuity conversion mentioned in the ANPRM:-
- The rate of interest is calculated to an equal proportion of the 10-year constant maturity Treasury securities rate for the Ist. business day of the last month against which the statement relates.
- Under Section 417(e)(3)B of the Internal Revenue Code, a mortality table will be applicable against which the statement co-relates i.e first day of the last month. This is a Unisex table and the annuity value will remain the same for males and females also.
- No-load for expenses, profit, reserves, etc. are charged by the insurance company.
Instructions
Procedure for pension calculation using current account balance and projected account balance:-
- Enter the participant’s Retirement Age. Under the ANPRM, 65 years is the normal retirement age under this plan. If the participant’s age is more than the actual age, in that case, the actual is to be considered.
- Then enter the participant’s Current Account Balance. This is the participant’s current account balance of the statement period.
- Then enter the participant’s Current Annual Contribution. Its means the amount which is contributed by the participant’s in the last 12 months and it includes both employer’s and participant’s contribution but does not include gain or loss for the year.
- Then enter the participant’s Years to Retirement. It means that the participants will enter the number of full years against which he is planning to take retirement. Generally, this figure will be equal to the Retirement Age entered above minus the participant’s age next birthday. If the participant has reached near Retirement Age, then enter zero.
- Then enter the Statement Date. In this column, you have to fill up the date of the last day of the statement period.
- Finally, click on the calculate button and thereafter you will see a chart of the current account balance and projected account balance.
For example, to match the results in the example in the ANPRM, you would enter (1) Retirement Age of 65; (2) Current Account Balance of $2,05,000; (3) Current Annual Contribution of $12,000; (4) Years to Retirement of 15; and (5) Statement Date of 05/15/2021.
Synopsis
This first row of the above results shows the Current Account Balance and also the projected monthly lifetime income payment against which the participant will receive today based on only the Current Account Balance (i.e. assuming that the participant will not contribute in the future). For example, if the Retirement Age entered is 65, the results will show monthly income (with no survival benefit) based on the Current Account Balance.
It also shows the amount against which the participant and the surviving spouse will receive the monthly income under a joint and survival benefit (with 50% of the contributor’s monthly amount paid to the surviving spouse), estimating that the participant and the spouse are of the same age.
The second row indicates the participant’s projected account balance what the participant will save when he will reach the Retirement Age. The projected account balance is including the sum of the Current Account Balance, assumed contributions from both the participant and employer between current and Retirement Age and also earnings on those amounts.
The projected account balance is changed into the participant’s monthly lifetime income as well as the joint and survival monthly lifetime benefit payments.
All of the above results shown are just projected and are not guaranteed to pertain to the account balance or of the lifetime income payments.
The Labor Department also does not monitor or save data that is entered by the participant online, and moreover, you cannot save calculations online. However, individuals are advised to copy or print the data into a text document on their computer before terminating the online session.
FAQs
Q. How many types of Pension Plans?
Ans. Generally, there are two types of pension plans — defined benefit plans and defined contribution plans. Under a defined benefit plan, there is a specific benefit at the time of retirement for each eligible employee and on the other side, defined contribution plans clarify that how many times contributions are made by the employer towards an employee’s retirement account.
In a defined contribution plan, a number of contributions as well as the gains or losses of account put an impact on the actual amount of retirement benefits of an employee.
Q. What is a Cash Balance Plan?
Ans. A cash balance plan is a defined benefit plan which shows benefits that there are more features in a defined contribution plan. In other words, a cash balance plan represents the committed benefit in terms of a stated account balance.
Q.How do Cash Balance Plans work?
Ans. Under a cash balance plan, a participant’s account is credited each year with a “pay credit” i.e. 5 per cent of compensation from his or her employer and an “interest credit” i.e. fixed rate or a variable rate which is linked to an index such as the one-year treasury bill rate. Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts committed to participants.
In this way, the investment risks are borne solely by the employer.
For example, suppose that a participant has an account balance of $205,000 when he or she reaches the age of 65. If the participant desires to retire at that time, the participant would have the right to an annuity based on that account balance.
Such an annuity might be approximately $17500 per year for life. In many cash balance plans, however, the participant could instead choose to take a lump-sum benefit equal to the $205,000 account balance.
The benefits in most cash balance plans, as in most traditional defined benefit plans, are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation.
Q. How do Cash Balance Plans differ from traditional pension plans?
Ans. Both traditionally defined benefit plans and cash balance plans are required to offer payment in the form of a series of payments for life.
Traditionally defined benefit plans illustrate an employee’s benefit of monthly payments for life to begin at retirement, while cash balance plans illustrate the benefit of a stated account balance. These accounts are often referred to as “hypothetical accounts” as they do not reflect actual contributions to an account or actual gains and losses allocated to the account.
Q. How do Cash Balance Plans differ from 401(k) plans?
Ans. Cash balance plans are defined benefit plans while 401(k) plans are a type of defined contribution plan. There are four major differences between cash balance plans and 401(k) plans:
- Participation – Participation in cash balance plans does not depend on the worker’s contribution part of their compensation to the plan, however, participation in a 401(k) plan does depend, whole or partially, on an employee choosing to make a contribution to the plan.
- Investment Risks – The investments of cash balance plans are arranged by the employer or an investment manager appointed by the employer. The employer also bears the risks of the investments. Increases and decreases in the value of the plan’s investments do not directly affect the benefit amounts committed to participants. 401(k) plans often permit participants to direct their own investments within certain categories. Under 401(k) plans, participants bear the risks and rewards of investment choices.
- Life Annuities – Apart from 401(k) plans, cash balance plans are required to offer employees the ability to receive their benefits in the form of lifetime annuities.
- Federal Guarantee – Since they are defined benefit plans while the benefits committed by cash balance plans are usually insured by a federal agency – the Pension Benefit Guaranty Corporation (PBGC). If a defined benefit plan is terminated with insufficient funds – the PBGC has the authority to assume trusteeship of the plan and to begin to pay pension benefits up to the limits set by law.
Q. Is there a federal pension law that governs these plans?
Ans. Yes. Federal law, the Employee Retirement Income Security Act (ERISA), the Age Discrimination in Employment Act (ADEA), and the Internal Revenue Code (IRC) provide specific protections to private-sector pension plans.
If your employer offers a pension plan, the law sets some measurements in the shape of responsibility, participation, vesting benefit accrual, and funding structure. The law also demands to give basic information to workers and retirees.
The Department of Labor, the Equal Employment Opportunity Commission (EEOC), and the IRS/Department of the Treasury have responsibilities to look after and implementing the provisions of the law.
Q. What happens to the assets in a plan when an employer converts its traditional defined benefit plan formula to a Cash Balance Plan formula?
Ans. When an employer modifies its plan i.e. to change the traditional defined benefit plan formula into a cash balance plan formula, the plan’s assets shall remain to continue from its initial date of the pension benefits under the plan. Employers cannot withdraw funds from the plan until the plan has not been terminated.
Q. How am I affected if I leave my job at a company that just changed its pension plan from a traditionally defined benefit formula to a Cash Balance Plan formula?
Ans. If you have worked a long time and vested enough money under the plan, you should receive the money as per hereunder calculations:-
(1) Flowing fixed benefit under the formula before the amendment or modification.
(2) To clarify additional benefits which will be earned under the plan formula after any modification or amendment.
However, you have to wait till retirement age under the plan to receive the actual benefit.
Q.Is my employer required to give me a choice of remaining under the old formula rather than automatically switching me to the new Cash Balance Plan formula?
Ans. Neither ERISA nor the IRC implements any rules on the employers to give employees the choice of remaining in the old formula. Moreover, employers consist of many options, such as :
a. Offering no choice, exchanging the old formula and applying the new formula to all participants.
b. Permitting employees to remain under the old formula and restricting new hires to the new formula
c. Set down certain employees who have reached a specific length of service or who have reached the age of retirement, may choose to stay with the old formula.
The law also gives permission to employers to do some changes in the old formula – whatever the option of implementation but the employer will have to satisfy the legal authorities.
Under each of these modified options, participants who have earned benefits already in the old formula can be converted into a cash balance formula but benefits will not be may not be reduced in any case.
Q. Will the conversion of my pension plan formula have an effect on my retiree health benefits?
Ans. No, Pension Plans and Health Plans are different plans and administered separately by the operating agencies. However, sometimes eligibility for retiree health benefits depends upon eligibility for pension benefits. If you have had any queries about your health benefits, you must contact your health plan administrator.