Retirement Planning Programs

There are four major types of qualified employer-sponsored retirement programs: pensions, profit-sharing and stock ownership plans, salary reduction, and thrift plans.

Pensions. Defined-benefit pensions provide benefits according to a formula based on income and/or years of service (e.g., two percent for each year of employment multiplied by a worker’s highest three or five year’s average pay). Benefits are unaffected by investment gains and losses and employers shoulder the risk of accumulating sufficient funds. Employer contributions are calculated according to actuarial tables.

Defined-contribution pensions provide benefits based on the performance of workers’ individual retirement savings accounts. Employers make contributions based on a fixed or variable percentage of pay, and workers receive the amount contributed plus plan earnings. Thus, employees shoulder the investment risk.

Cash-balance pensions became increasingly popular during the 1990s. Benefits accrue at an even rate throughout workers’ careers, in contrast to the higher benefits toward the end of a career offered by defined-benefit pensions. Employers contribute a percentage of workers’ salaries and credit a return that is generally tied to a market index. Cash-balance plans are controversial because workers with long service often earn less than they would have if their employer retained a defined-benefit plan. Some workers have responded with charges of age discrimination.

Profit-sharing and stock ownership plans. Profit-sharing plans allow employers to make flexible contributions contingent upon company profits. There is no requirement that contributions be made annually. Instead, they are decided by a corporation’s board of directors and can be lean or generous, depending on company earnings. Because of the uncertainty of payment, profit-sharing plans often supplement a pension. The maximum allowable contribution is $40,000 or 100 percent of compensation; if less, beginning in 2002.

Stock bonus plans are similar to profit-sharing plans, except that contributions do not depend upon profitability and are made in the form of company stock. Employee stock ownership plans (ESOPs) provide shares of company stock as an employer’s retirement fund contribution. They provide a ready market for corporate stock, a feeling of participation in company management, and an incentive for employees to work hard.

Incentive stock options are sometimes provided to nonmanagerial employees, especially in start-up companies. They allow the holder to receive cash or stock after a specified vesting period, generally three to five years. Many people use this money for retirement.

Salary reduction plans. These plans allow workers to save a portion of their income, tax-deferred. These plans are named for specific sections of the tax code.

401(k) plans allow employees of for-profit corporations to save up to $11,000 (year 2002 limit) annually for retirement. The contribution and earnings are tax-deferred until withdrawal. Many employers also match employee contributions by a certain percentage and allow participants to borrow up to half of their account balance. The deferral limit will increase to $12,000 in 2003, $13,000 in 2004, $14,000 in 2005, and $15,000 in 2006.

403(b) plans are available to employees of non-profit organizations, such as public schools, hospitals, and public and private universities. The 2002 contribution limit is also $11,000 and gradually rises to $15,000 like 401(k)s. Fewer employers match contributions because many participants are public employees. Plans include catch-up provisions for workers who did not contribute fully in the past.

457 plans are available to state and local government workers and tax-exempt organizations. The maximum 2002 contribution is $11,000 and employer matching is rarely available.

For all of the above plans, participants age 50 and older who have made the maximum deferral can contribute an additional ‘‘catch up’’ amount: $1,000 in 2002, $2,000 in 2003, $3,000 in 2004, $4,000 in 2005, and $5,000 in 2006 and later.

Thrift plans. These are after-tax, employer-sponsored savings programs. In other words, workers cannot deduct their contributions from gross income, as is possible with salary-reduction plans. Employers generally match thrift plan contributions at a certain rate. For example, with a 50 percent match, an employer would contribute fifty cents for every dollar saved by employees.