Defined Pension Plans and Vested Benefits
Defined pension plans specify either how much money is invested into a retirement pension or how much is distributed after retirement. These two types of defined pension plans are referred to as defined benefit and defined contribution pension plans. Vested benefits, also known as vested rights, refer to the value a pensioner has accumulated within a pension. Both defined contribution and defined benefit plans allow vested benefits to accrue over time.
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Regulation
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Defined benefit and defined contribution plans that are privately managed are regulated by the Employee Retirement Income Security Act of 1974. Employers that choose to offer defined contribution and benefit plans must disclose legally specified information about pension plan benefits to their employees. These rules are codified in Title 29, Chapter 18 of the U.S. Code.
Benefits
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Defined benefit plans do not comprise the majority of pension plans in the U.S., according to the Internal Revenue Service. These types of pension plans accumulate federally insured vested benefits either using a formula or an amount indicated in the pension plan's design. These benefits may be received in one payment or in a periodic series of payments. Another type of defined benefit plan is the cash-value pension plan; this defines benefits in terms of the cash value of the plan at the time of retirement.
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Contributions
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The U.S. Department of Labor states an employee, an employer or both parties can contribute to defined contribution pension plans in accordance with each other. Employer 401k retirement plans are a kind of defined contribution pension plan. The 2011 maximum contribution amount to this type of plan is $16,500, but individuals over 50 years of age can contribute an extra $5,500 for the same year. An advantage of defined contribution plans is they can be transferred to an individual retirement account, whereas defined benefit plans cannot.
Formulas
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A pension plan formula sometimes determines how much vested benefit an employee is eligible to receive. These formulas vary by the institution through which the pension is established. For example, the U.S. Social Security Administration calculates Social Security income from vested benefits based on the age of the retiree, when the application for benefits is made and annual income amounts prior to the date of application.
Matching
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When an employer contributes to a pension plan, a specific percentage of an employee's invested salary can be matched. For example, if an employee has $500 a month taken out of pretax income, and places the money in a 401k, the employer may match 5 percent, or $25, of the contribution. If an employer claims to have 100 percent contribution matching, it may only mean a percentage of the employer's maximum pension payment is matched. To illustrate, if the employer match is 5 percent, a 100 percent match is 5 percent.
Warnings
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The Consumers Union of the U.S. Inc. claims there are several ways in which vested benefits can be limited. These include pension freezes, cash-balance conversions and benefit formula changes. In other words, even though pensions are insured, the vested benefits are not guaranteed and can be reduced. These types of changes can negatively impact a retiree's financial plan, and are ideally accounted for with the use of supplemental or contingency retirement plans.
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