Retirement Plan

What is a Retirement Plan?

A retirement plan is an arrangement to provide people with an income, or pension, during retirement, when they are no longer earning a steady income from employment. Retirement plans may be set up by employers, insurance companies, the government or other institutions such as employer associations or trade unions. Retirement plans are more commonly known as pension schemes in the UK and Ireland and superannuation plans in Australia.

Types of Retirement Plans

Retirement plans may be classified as defined benefit or defined contribution according to how the benefits are determined.

Defined Benefit Plan

A defined benefit plan guarantees a certain payout at retirement, according to a fixed formula which usually depends on the member's salary and the number of years' membership in the plan.

Traditionally, retirement plans have been administered by institutions which exist specifically for that purpose, by large businesses, or, for government workers, by the government itself. A traditional form of defined benefit plan is the final salary plan, under which the pension paid is equal to the number of years worked, multiplied by the member's salary at retirement, multiplied by a factor known as the accrual rate.

The final accrued amount is available as a monthly pension or a lump sum.

In addition, many countries offer state-sponsored retirement benefits, beyond those provided by employers, which are funded by payroll or other taxes. In the U.S., this is one role of Social Security.

Defined benefit plans may be either funded or unfunded.

In a funded plan, contributions from the employer, and sometimes also from plan members, are invested in a fund towards meeting the benefits. The future returns on the investments, and the future benefits to be paid, are not known in advance, so there is no guarantee that a given level of contributions will be enough to meet the benefits. Typically, the contributions to be paid are regularly reviewed in a valuation of the plan's assets and liabilities, carried out by an actuary. In many countries, such as the USA, the UK and Australia, most private defined benefit plans are funded, because governments there provide tax incentives to funded plans.

In an unfunded plan, no funds are set aside. The benefits to be paid are met immediately by contributions to the plan. Most government run retirement plans, such as the social security system in the USA and most European countries, are unfunded, with benefits being paid directly out of current taxes and social security contributions. In some countries, such as Germany, Austria and Sweden, company run retirement plans are often unfunded.

Defined Contribution Plan

A defined contribution plan will provide a payout at retirement that is dependent upon the amount of money contributed and the performance of the investment vehicles utilized.

In a defined contribution plan, contributions are paid into an individual account for each member. The contributions are invested, for example in the stock market, and the returns on the investment (which may be positive or negative) are credited to the individual's account. On retirement, the member's account is used to provide retirement benefits, often through the purchase of an annuity which provides a regular income. Defined contribution plans have become more widespread all over the world in recent years, and are now the dominant form of plan in the private sector in many countries. For example, the number of DB plans in the US has been steadily declining, as more and more employers see the large pension contributions as a large expense that they can avoid by disbanding the plan and instead offering a defined contribution plan.

Examples of defined contribution plans in the USA include Individual Retirement Accounts (IRAs) and 401(k) plans. In such plans, the employee is responsible, to one degree or another, for selecting the types of investments toward which the funds in the retirement plan are allocated. This may range from choosing one of a small number of pre-determined mutual funds to selecting individual stocks or other securities. Most self-directed retirement plans are characterized by certain tax advantages, and some provide for a portion of the employee's contributions to be matched by the employer. In exchange, the funds in such plans may not be withdrawn by the investor prior to reaching a certain age.

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Ten Steps for Retirement Preparedness

Are you planning to retire?

Assessing how ready you are to retire includes knowing how financially prepared you are - not just to retire, but to address the unique financial needs you'll have throughout your retirement years. You should develop the most appropriate retirement plan for your needs. Understand your priorities, personal goals, financial resources and how you want to approach your retirement plan for you to be able to reach your financial goals.

As with any large undertaking, preparing for retirement can be less daunting if broken down into smaller, achievable goals.

“Retirement Reality Check” survey shows that in 2004, overall, Americans believe they're taking the right steps to prepare for retirement, with 76 percent of respondents saying they are "somewhat" or "very" prepared financially. Yet, many still have some looming concerns about retirement expenses.

Despite these concerns, a mere eight percent of survey respondents have implemented all 10 recommended retirement preparation steps, which could be an indicator that someone is on track to meeting their retirement goals. By establishing retirement goals and the cost to achieve those goals early on, Americans can be on the path to a solid financial future.

Ten recommended retirement-preparation steps are:

1. Educate yourself on the different savings options available and what might work for you. One investment may work for certain individuals or situations, but not for others.

2. Discuss with your spouse how the two of you want to spend retirement. Don't wait until retirement to learn you have conflicting goals.

3. Decide on an age to retire and how much you will need to save each month until then. Saving even a small amount can add up to a lot over time.

4. Determine how much you will spend each year in your retirement to maintain the lifestyle you want.

5. Set up a plan to automatically save a fixed amount each month. Remember, if you begin saving less than the designated monthly amount, you may have to add significantly to your savings later in life.

6. Decide which savings vehicles will help you best prepare for retirement; keeping in mind how many years remain before retirement, and the kind of lifestyle you'd like to have.

7. Monitor your savings and investments over time to determine whether you need to make adjustments to keep on track with your goal.

8. Estimate how much you will receive from Social Security and/or from any employer-sponsored retirement plans.

9. Work with a financial professional to help ensure your insurance needs are adequate and keeping up with changes in your life.

10. Make sure your retirement plan has a financial cushion that allows for unexpected events and expenses.

Source: womens-finance.com