Pension plans

A pension plan is an employee benefit plan established or maintained by an employer or by an employee organization such as a union—or both—that provides retirement income or defers income until termination of covered employment or beyond. There are a number of types of retirement plans, including the 401k plan and the traditional pension plan, known as a defined benefit plan.

The Employee Benefits Security Administration

The Employee Benefits Security Administration (EBSA) of the Department of Labor is responsible for administering and enforcing the provisions of the federal Employee Retirement Income Security Act (ERISA). ERISA covers most private sector pension plans. One of EBSA's responsibilities is to provide consumer information on pension plans, and compliance assistance for employers, plan service providers, and others to help them comply with ERISA.

ERISA

ERISA provides protections for participants and beneficiaries in employee benefit plans, such as access to plan information. Also, those individuals who use discretion in managing plans and controlling the plan’s assets must meet certain standards of conduct under the fiduciary responsibilities specified in the law.

Pension Benefit Guaranty Corporation

The Pension Benefit Guaranty Corporation (PBGC) can answer your questions about defined benefit plans. These traditional plans promise workers a specific monthly benefit at retirement. The PBGC also provides a Pension Search Directory to help reunite people with their missing pensions.

ERISA covers two types of retirement plans: defined benefit plans and defined contribution plans.

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, one percent of average salary for the last five 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 PBGC.

A defined contribution plan, on the other hand, does not promise a specific amount of benefits at retirement. In these plans, the employee or the employer (or both) contribute to the employee's individual account under the plan, sometimes at a set rate, such as five 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.

Simplified Employee Pension Plan (SEP)

A Simplified Employee Pension Plan (SEP) is a relatively uncomplicated retirement savings vehicle. A 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 a 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.

Profit-Sharing Plan or Stock Bonus 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 profit-sharing plan or stock bonus plan may include a 401(k) plan.

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 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.

Employee Stock Ownership Plan (ESOP)

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

Cash Balance Plan

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 five 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 PBGC.

In Texas, as in other states, pension plans are primarily regulated by federal law, specifically the Employee Retirement Income Security Act (ERISA). ERISA sets minimum standards for most voluntarily established pension and health plans in the private industry to provide protection for individuals in these plans. The Employee Benefits Security Administration (EBSA) oversees ERISA compliance and offers assistance to consumers, employers, and service providers. Pension plans are generally categorized into defined benefit plans, which promise a specific monthly benefit at retirement, and defined contribution plans, where the retirement benefit is based on contributions plus investment gains or losses. The Pension Benefit Guaranty Corporation (PBGC) insures benefits for most traditional defined benefit plans. Other types of plans include Simplified Employee Pension Plans (SEPs), Profit-Sharing or Stock Bonus Plans, 401(k) plans, Employee Stock Ownership Plans (ESOPs), and Cash Balance Plans. Texas state law may provide additional regulations for public employee pension plans, but private sector plans are largely governed by ERISA and not subject to state-level regulation regarding their structure and benefits.