Getting to know the types of retirement plans that are available for you is important when planning retirement. In another article we covered the most common types of retirement plans, which are defined benefit plans and defined contribution plans, in which plans like IRAs, 401(k) and Social Security are included. However, there are other types of retirement plans that usually combine the characteristics of the two previously mentioned, so today we will explain you what you need to know about them.
Hybrid and cash balance plans
Hybrid plans combine the characteristics of the two types of retirement plans previously explained, which are defined benefit and defined contribution plans.
For taxes, accounting and regulatory purposes they are considered as defined benefit plans. The major risk of the investment is assumed by the plan sponsor, as in defined benefit plans, but the benefits are expressed as a notional account balance and they are paid as cash balances when the employment is going to end, just like defined contribution plans.
A common example of a hybrid designed plan is the Cash Balance Plan, where the employee’s notional account balance grows by some defined rate of interest and annual employer contribution, and it maintains hypothetical individual employee accounts.
Qualified Retirement Plans
Qualified plans receive favorable tax treatment and are regulated by the Employee Retirement Income Security Act (ERISA). However, there are plans that are not considered as qualified, like 401(k), but they are treated and taxed the same.
If a plan wants to receive favorable tax treatment, it must meet some strict requirements, such as offering life annuities in the form of a Single Life Annuity (SLA) and a Qualified Joint & Survivor Annuity (QJSA) and maintaining sufficient funding levels.
In 401(k) plans, the retirement saving contributions is provided by an employer and deducted from the employee’s paycheck before taxation. In some cases, the employer may match these contributions.
There are some rules related to 401(k) plan. The most important is that there is a limit on the amount an employee may elect to defer from his or her salary before taxation each year.
Employees who have 401(k) are in charge of their retirement income by contributing part of their salary and directing their own investments.
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SIMPLE Individual Retirement Accounts (IRAs)
SIMPLE IRAs are types of retirement plans provided by an employer which are similar to 401(k). The differences are that they offer simpler and cheaper administration rules and contribution limits are lower than other types of employer-provided retirement plans. SIMPLE IRAs are funded by before taxation salary reductions.
Simplified Employee Pension Individual Retirement Accounts (SEP IRAs)
SEP IRAs are usually used by business owners to provide retirement benefits for the business owner and their employees. These plans allow employees to make contributions on tax-favored basis to their Individual Retirement Accounts (IRAs) and funds can be invested. There aren’t significant reporting and disclosure requirements and all employees have to receive the same benefits in a SEP plan.
As indicated by its name, nonqualified plans are plans that do not meet the requirements to receive favorable tax treatment and they are excluded from the restrictions applied to qualified plans.
Some nonqualified plans are 457(f) plans and Supplement Executive Retirement Plans (SERP). They are used to give additional benefits to important or highly paid employees, like executives.
Keogh plans, also known as HR10, are retirement plans designed for self-employed people and small businesses. There are defined contribution Keogh plans and defined benefits Keogh plans. Their main benefit when compared to other retirement plans is that they offer higher limits of contribution.