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What is a pension plan

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  • Pensions
  • Posted date:
  • 05-08-2019
What is a pension plan

A pension plan entails retirement plans where employers contribute specific amounts of money and then paid out to an employee during retirement. A typical pension plan type is the defined benefit plan. In this type, the employer specifies typically the pension payment or the lump sum they will give to an employee on retirement.

In this case, certain factors like the worker's salary, time of service, and many more determine the amount paid. Other than the pension plans that entail the employer's contributions, some pension plans allow employees to also contribute to their retirement fund. Employees do this by providing part of their wages/ salaries to an investment plan.


TYPES OF PENSION PLANS

The two major types include the defined contribution pension plan and the defined benefit pension plan.

DEFINED BENEFIT PENSION PLAN

With a defined benefit plan, the employer specifies the amount of pension or retirement benefit they will give the employee upon retirement. Various factors usually determine the retirement benefit, including the employee's earnings and the time they have worked in the company. The longer you work, the more benefits you are paid.

The employer contribution to these plans is determined by the employee's retirement age, their life expectancy, possible fluctuations of interest rates in the future, and the employees' turnover possibility. In the past years, many UK companies offered a defined benefit pension plan to their employees. However, this has slowly changed over the years, and most of the companies do not give this pension plan to new employees.

In contrast to UK companies, 90% of public employees in the US are covered by the defined benefit pension plan while the number of private employees referred to using these plans are as low as 10%.

DEFINED CONTRIBUTION PLAN

Defined contribution plan is a pension plan in which both the employer and the employee contribute a specified amount of money. The money is then invested to be used as the retirement benefit of the employee.

Contributions from the employee and the employer are invested in various areas, such as the stock market. The returns obtained from investments are credited to the employee's account. You usually get 25% on your pension tax-free, and the provider may take a small management fee. 

In the long run, the performance of the investments goes a long way in determining the retirement benefit the employee will get. 

Employees can get regular incomes from their accounts by purchasing an annuity. In the UK, this pension plan has become very common since the defined benefit pension plans no longer cover new employees.

Most companies worldwide are shifting from the defined benefit plan and are slowly incorporating the defined contribution plans. However, some companies have two pension plans.The defined benefit plan is not as risky since the employees are guaranteed to receive a specified amount. On the other hand, defined contribution plans are quite dangerous since the employee might incur a loss in investment.


Paul Dodd Asset Management Limited is committed to providing independent financial management throughout Leeds and North Yorkshire. If you need to speak to our pension planning specialist today, please get in touch to discuss the ways that we can help you.