What is a Pension Plan

A pension plan is a type of retirement plan where an employer makes contributions toward a pool of funds set aside for an employee’s future benefit. Generally speaking, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. Proper pension planning is important because it can take on different forms and each has their own benefits.

There are two main types of pension plans: defined-benefit plans and defined-contribution plans. A defined-benefit plan guarantees a certain payout to the employee at retirement. This is according to a fixed formula which usually depends on the member’s salary and the number of years in the plan so there is very little effort required on the part of the employee. In this type of plan, the performance of the underlying investment is irrelevant. The employee will know what they will receive when they retire, and they can even choose to take a reduced monthly payment so their spouse may continue receiving payments if they die first.

A defined-contribution plan will provide a payout at retirement that is dependent upon the predefined amount of money contributed and the performance of the investment vehicles utilized. Only employer contributions to the account are guaranteed, not the future benefits. So, the employee will never really know the exact amount they will have at retirement and can choose to be conservative or take more risk with the money. This leaves a little more uncertainty to the plan, but if the employee makes some good decisions it could pay off. Some other types of retirement plans, such as cash balance plans, combine features of both defined benefit and defined contribution plans and are often referred to as hybrid plans.

A type of pension plan that may be better for small businesses is a Simplified Employee Pension plan or SEP. Under a SEP, an employer contributes directly to an individual retirement account (IRA) for each employee, including themselves. SEP’s are easy to set up and the administrative costs are low. This makes SEP’s a great choice for sole proprietors and partnerships.

Whether you’re a company looking to set up a pension plan, or an employee trying to figure it all out, it is highly advisable to consult with a wealth manager of financial advisor to see which plan fits the best. Clay Northam Wealth Management can assist in your retirement plan and pension planning and give you piece of mind that you have the proper plan for you. Servicing all of Southern California, we have two convenient offices located in the Los Angeles and Orange County. Please to not hesitate to contact our offices to see how we can be of value to you.