Explaining the Various Retirement Plans

Here is an explainer of benefits plans available to employees, according to the Employee Benefits Security Administration and 401khelpcenter.com:

Defined contribution plans: These are account-based plans and are typically 401(k) plans; all participating employee have an account where they contribute pretax salary dollars and choose from an investment menu provided by the employer. Employers can choose to match employee contributions up to 6 percent. Also, the Internal Revenue Service places a ceiling on how much employees can contribute each year. In 2011, the limit, which doesn’t include the employer contribution, is $16,500. People 50 and over can make $5,500 in catch-up contributions for a maximum of $22,000 this year. Nearly all final payouts are in lump sums.

Traditional defined benefit plans: These are employer-sponsored plans, where the employer defines the benefit paid out for life to the employee. The final benefit is determined by a formula, usually based on years of service and final year or years of pay. The plan is funded and invested solely by the employer. The final payout is in the form of an annuity.

Cash balance plan: These are defined benefit plans, but like defined contribution plans, are account-based. In each account, employees get two different types of credits established by the employer: a pay credit and an interest credit. The pay credit is percent-based on an employee’s salary and is contributed to the account. The interest credit set by the employer is applied to the amount in the account. The plan’s assets are invested by the employer, but the employee accounts are not subject to the volatility of the investments because of the preset interest credit. The final payout can come as a lump sum or annuity.

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