Pension Plan Basics
Money Purchase Plan
An employer's annual contribution to a money purchase plan is required. He can't take a year off because business is slow and profits are down.
A money purchase plan is a qualified employer retirement plan in which each employee has an individual account. The employer must make annual contributions to each employee's account. The amount of contribution is determined by a pre-set formula, based on a fixed percentage, or a flat monetary amount.
The formula requires an employer to contribute a specified percentage (up to 25 percent) of each employee's compensation. Money purchase plans are expensive for the employer, and are not as common as other plans. If the employer can't make his required annual contributions, he is penalized.
Some money purchase plans may allow employees to add to the employer's contribution, but the employee would have to pay taxes up front on the money he contributed.
Profit Sharing Plans
A profit sharing plan is a qualified, defined contribution plan in which an employer contributes money to employees' accounts, based on the amount of profit the company has realized that year.
The employer gets to decide how much to contribute, and is not obligated to contribute anything if the company has not been profitable. Although an employer can contribute up to 15 percent of each employee's salary into his or her account, the average contribution usually is between 2 and 5 percent.
A profit sharing plan can be done in conjunction with another retirement savings plan, but sometimes it is the only type of plan available within a company. Employees may add to their employer's contribution, either with pre-tax or post-tax money.
Target Benefit Plan
A target benefit plan is an age-weighted plan that's normally used by a company that wishes to have a specified sum available for an older employee (usually an owner) at the time of retirement.
These plans are expensive, and usually employed by companies in which the owners have been unable to contribute to retirement funds while they were building up the company. Once the company starts to be profitable and retirement money is available, the owners try to compensate for their previous lack of retirement saving.
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Excerpted from The Complete Idiot's Guide to Personal Finance in Your 40s and 50s © 2002 by Sarah Young Fisher and Susan Shelly. All rights reserved including the right of reproduction in whole or in part in any form. Used by arrangement with Alpha Books, a member of Penguin Group (USA) Inc.
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