A guide to U.S. retirement accounts

What does your ideal retirement look like? Traveling the world? Spending more time with family? Or taking it easy by the beach?  Your dream has to start with knowing how you will finance your life after employment.  For most of us, that's where retirement plans come in. Learn more about what kind of plans are out there and which is best for you. Plus, browse our other resources to help you reach your retirement goals.

The basics

A retirement plan is a financial arrangement that provides income during retirement. Retirement plans can be set up by employers, insurance companies, trade unions, the government, or other institutions. The Employee Retirement Income Security Act (ERISA) -- a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry -- covers two types of plans: defined benefit plans and defined contribution plans.

Types of plans
Credit: U.S. Department of Labor

A defined benefit plan promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service. For example, 1 percent of average salary for the last 5 years of employment for every year of service with an employer. The benefits in most traditional defined benefit plans are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC).

A defined contribution plan does not promise a specific amount of benefits at retirement. In these plans, the employee, the employer, or both, contribute to the employee's individual account under the plan (sometimes at a set rate, such as 5 percent of earnings annually). These contributions generally are invested on the employee's behalf. The employee will ultimately receive the balance in their account, which is based on contributions plus or minus investment gains or losses. The value of the account will fluctuate due to the changes in the value of the investments. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans.

A Simplified Employee Pension Plan (SEP) is a relatively uncomplicated retirement savings vehicle. An SEP allows employees to make contributions on a tax-favored basis to Individual Retirement Accounts (IRAs) owned by the employees. SEPs are subject to minimal reporting and disclosure requirements. Under an SEP, an employee must set up an IRA to accept the employer's contributions. Employers may no longer set up Salary Reduction SEPs. However, employers are permitted to establish SIMPLE IRA plans with salary reduction contributions. If an employer had a salary reduction SEP, the employer may continue to allow salary reduction contributions to the plan.

A Profit Sharing Plan or Stock Bonus Plan is a defined contribution plan under which the plan may provide, or the employer may determine, annually, how much will be contributed to the plan (out of profits or otherwise). The plan contains a formula for allocating to each participant a portion of each annual contribution.

A 401(k) Plan is a defined contribution plan that is a cash or deferred arrangement. Employees can elect to defer receiving a portion of their salary -- which is instead contributed on their behalf -- before taxes, to the 401(k) plan. Sometimes the employer may match these contributions. There are special rules governing the operation of a 401(k) plan. For example, there is a dollar limit on the amount an employee may elect to defer each year. An employer must advise employees of any limits that may apply. Employees who participate in 401(k) plans assume responsibility for their retirement income by contributing part of their salary and, in many instances, by directing their own investments.

An Employee Stock Ownership Plan (ESOP) is a form of defined contribution plan in which the investments are primarily in employer stock.

A Money Purchase Pension Plan is a plan that requires fixed annual contributions from the employer to the employee's individual account. Because a money purchase pension plan requires these regular contributions, the plan is subject to certain funding and other rules.

A Cash Balance Plan is a defined benefit plan that defines the benefit in terms that are more characteristic of a defined contribution plan. In other words, a cash balance plan defines the promised benefit in terms of a stated account balance. In a typical cash balance plan, a participant's account is credited each year with a "pay credit" (such as 5 percent of compensation from his or her employer) and an "interest credit" (either a fixed rate or a variable rate that is linked to an index such as the one-year treasury bill rate). Increases and decreases in the value of the plan's investments do not directly affect the benefit amounts promised to participants. Thus, the investment risks and rewards on plan assets are borne solely by the employer. When a participant becomes entitled to receive benefits under a cash balance plan, the benefits that are received are defined in terms of an account balance. The benefits in most cash balance plans, as in most traditional defined benefit plans, are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC).


Check out more of our coverage on retirement


Retirement calculators
Trying to figure out how much you should save for retirement? Here are a few handy calculators to help you reach your retirement goals:

More resources from the Department of Labor

About the author

Daryl Paranada is the associate web producer for Marketplace overseeing all daily website content and production, as well as producing multimedia features -- including the popular economic explainer series Whiteboard -- and special projects. Follow him on Twitter @darylparanada.

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