Understanding Pension: Meaning and Types

  • Pension
Understanding Pension

Pension plan or a retirement plan is something that holds prime ground of importance. The many benefits and features of this plan tend to be advantageous to the people who need it at the most. But apart from the usual set of features, the plan does have certain other aspects that are usually ignored. Although you might come across the same when the time comes, it is not right to do so. You must be completely aware of all the aspects that revolve around pension so that you can understand whether or not you are getting all that you need. So to help you out on that front, here are some essential points that you need to know about a pension.

1. Meaning

To make things precise, let’s start with the meaning of pension and understand how it affects us further down the road. On that note, you must know that a pension or a retirement plan requires an employer to make contributions to pool funds in order to set aside for a worker’s benefit. This pool of funds will be invested on behalf of the employee, and the earnings that generated from the investments tend to go to the worker upon his/her retirement. Apart from contributions emerging from the employer’s side, pension plans also tend to have a voluntary investment component. Due to that, employees are also encouraged to make contributions of their choice.

2. Types

When it comes to pension plans, there are mainly two types. These plans are defined-benefits plans and defined-contribution plans.

a. Defined-Benefit Plans

According to this particular plan, the employer guarantees and ensures that the employee receives a definite amount during the time for retirement. This goes into account regardless of the performance of the investment pool or how it turns out to be. The employer, by all means, is liable for a specific flow of pension payments to the individual who’s about to retire. But in case the assets of the plan do not meet the required set of criteria, then the company or the management pays for the remainder of the payment.

b. Defined-Contribution Plans

A defined-contribution plan is quite different from a defined-benefit plan. Here the employer makes specific plans of contributions to the employee similar to what he/she contributes to the company. So the final benefit that is received by the employee will depend upon the employee’s performance and other such criteria. The company’s liability tends to end when such contributions are made. Due to the nature of this benefit, private companies tend to go for this plan as it suits their current mode of operation. Hence, that stands to define the contributions plan.

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