As with any other aspect in life, selecting a suitable retirement plan is all about making the right decision at the right time. The decision cannot, and should not, be taken on an impulse. One would need to understand the various options available and analyze the plans on the basis of individual contexts. A large number of companies provide retirement plans integrated with other benefits to the employees. So, it somewhat makes the job of selection of a suitable pension plan easier. But if your company unfortunately does not offer any such option, then one needs to pick a pension plan offered by an independent financial institution.
The Different Types Of Retirement Plans
There are various types of pension plans, which can be fundamentally divided into two groups: defined benefit scheme and defined contribution scheme. The former has been slowly fading out of the scene, and the latter has been gaining in popularity. The most popular types of defined contribution schemes are the individual retirement account (IRA) and 401(k) plans.
In the defined benefit scheme, which has been the traditional favorite, the employee gets a fixed amount after retirement, which depends on the number of years in service and the average salary. The employer and, in some cases, the government provide the funds for giving a fixed amount as the monthly pension to the employee. There are options to avail this money as a lump sum also.
But in the defined contribution plans, the employee has to contribute a certain amount from his or her gross salary. This amount is then invested in various investment vehicles such as government bonds, debentures, mutual funds, and the share market. The employee can specify the type of investment channels to be used. The money that one gets after retirement depends on the total amount deposited and the performance of the investment vehicle selected.
It can be easily understood that the defined contribution system provides more options and flexibility of financial planning to an employee. The jury is still undecided about the comparative merits and demerits of both the systems. But it is safe to say that, for a person with decent knowledge about financial systems, the defined contribution system is surely a good one. In any case, almost all organizations are slowly moving towards adopting this system. In the final count, it only means one thing: employees need to acquire decent knowledge about financial systems.
In addition to the above two plans, there are some schemes called as hybrid schemes. Such schemes, as the name indicates, are a mixture of both the defined benefit and defined contribution schemes. In simple terms, these are defined benefit schemes that are made to appear like defined contribution scheme.
IRA and 401(k) plans are the most widely used defined contribution schemes. Any person with a source of income can opt for an IRA. It is not necessary that the person should have a full time job. Also, a person can opt for several IRAs. There are 11 types of IRAs at present. While choosing an IRA, one has to make regular contributions to the scheme. The money invested in IRA is not taxable at the time of investment. But tax will be deducted when the person avails the benefit. However, there are certain schemes like the Roth IRA in which the pension amount is not taxable.
In the 401(l) plan, the employee makes a certain contribution and the employer also has to pay a certain portion of that amount. This contribution is not taxable. However, tax will be deducted when the person gets the benefit of the scheme.