Pension plan definition
/What is a Pension Plan?
A pension plan is an arrangement under which an employer pays into a pool of funds that will be used to provide benefits to employees when they are retired. The funds in the pool are then invested on behalf of the employees, so that the initial contribution plus subsequent investment income will be available to pay benefits. These arrangements are usually tax advantaged.
Types of Pension Plans
There are two main types of pension plans, which are as follows:
Defined contribution plan. Under this plan, the employer is only liable to make a certain contribution amount to the plan. This strictly limits the employer’s pension payments, which makes this by far the most popular plan among employers.
Defined benefit plan. Under this plan, the employer must provide a specific type and amount of benefit to retired employees in the future. The employer may have to keep paying into this plan for an extended period of time to ensure that all benefits are funded. Since this approach results in better benefits for employees, it is favored by unions.