Understanding the Corporate Pension Plan

by Investing School on September 14, 2012

A corporate pension plan is a formal agreement that is entered into by a company and its employees that will provide retirement funding for the employees of said company. While there are nuances to any such agreement there are two types of funding which are most common: contributions and benefits.

With a defined-benefit arrangement the employee’s retirement benefits are calculated according to a formula which is determined by the length of employment and salary. It is up to the employer to fund the plan.

In the case of a defined-contribution agreement there is no guaranteed amount that the employee will receive upon retirement. The payout from such a plan depends upon how well the investment plan performed. In this arrangement both the employee and the employer contribute to the plan.

Maximum tax-deferred contributions are limited by law but do not include matching contributions provided by the employer. Generally, employees can choose from a pool of investments into which they deposit their funds.

It used to be fairly common that companies would offer defined-benefit plans that guaranteed former employees payouts which would continue until they died. Guaranteed income which will continue throughout one’s retirement is a tremendous incentive and is a major strategic resource for companies which want to attract the best employees in the field. Supporting such plans can be a tremendous drain upon a company.

Today, companies are moving towards defined-contribution plans instead. Such plans allow them to adjust benefits as the company’s fortunes change and as the market moves up and down as well.

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