“You can be young without money but you can’t be old without it”. Words of wisdom worthy of the acclaimed playwright Tennessee Williams.

Retirement is one of the most important life events you’ll experience and needs careful planning and budgeting to ensure financial security in your senior years.

These days, people are more likely to delay retirement and continue working longer or to work part-time in retirement. Even so, with or without the idyllic images of the cruiser and the beach lounge chair, fact is you cannot achieve retirement unless you have sources of income that do not have to be earned by working. Consider this, as well, if you retire at 70 and live to 100, your money needs to last for 30 years!

Without any further ado, let’s start our journey into the pension plans domain.

We should first clarify the use of the terms “retirement” and “pension”. When it is retirement time, you may be covered by a pension plan at your employer, or you could have a retirement account that you contribute to. Both of these plans can provide you with benefits once you reach retirement age. In other words, a pension plan is a type of retirement plan that is always employment related.

A retirement plan is one of the most important and meaningful benefits the employer can offer to the employees, and they are advantageous for business owners and employees as well, mostly for tax reasons. They are deferred savings tools that allow the tax-free accumulation of a fund for later use as a retirement income.

Retirement plans may be set up by employers, insurance companies, the government or other institutions such as employer associations or trade unions. (We are not going to talk about Social Security here because it is actually a social insurance and not a retirement plan.)

Qualified retirement plans (QRP) receive special tax treatment and are thus subject to very strict government regulations, as opposed to non-qualified retirement plans which receive fewer tax benefits and have more flexible regulations.

QRP’s are certified by the Internal Revenue Code Section 401(a) of the IRS and the Employee Retirement Income Security Act of 1974 (ERISA).

ERISA is a federal United States tax and labor law that establishes minimum standards for pension plans in private industry. It contains rules on the federal income tax effects of transactions associated with employee benefit plans.

A qualified retirement plan is one that meets ERISA guidelines, while a non- qualified plan falls outside of ERISA guidelines. Qualified plans include 401(k), profit sharing plans, 403(b), and Keogh (HR-10) plans.

Non-qualified plans are those that are not eligible for tax-deferral benefits under ERISA and are mostly designed for executives or key-employees. Deducted contributions for non-qualified plans are taxed when the income is recognized. In other words, the employee will pay taxes on the funds before they are contributed to the plan. Non-qualified plans include deferred-compensation, split-dollar life insurance, and executive bonus plans.

According to how the benefits are determined, QRPs are classified as defined benefit plans and defined contribution plans.

With a Defined Benefit Plan, your benefits on retirement are predetermined, following a set formula that can include your pay, years of employment, age at retirement and other factors. In the private sector, defined benefit plans are often funded exclusively by employer contributions. These plans are also known as company retirement plans.

Self employed business owners with high income and the goal to maximize their tax deductible retirement contributions frequently create their own defined benefit pension plan.

Defined benefit plans can be funded or unfunded.

In a funded defined benefit plan, contributions from the employer and plan members are invested in a fund. Depending on future returns on the investments and the future benefits to be paid, contributions may be regularly reviewed to ensure that the pension fund will meet future payment obligations. (The Social Security system is similar to this kind of plans.)

In an unfunded defined benefit plan no assets are set aside and the benefits are paid for by the employer or other pension sponsor as and when they are paid.

In a Defined Contribution Plan, you, as well as your employer, may contribute to the plan. The contributions, which are paid into your individual account, are invested and the returns on the investment are deposited to your account.

So practically, with a defined contribution plan your retirement benefits are based on the amount contributed to the account, with the income, gains, losses and expenses allocated to your account. Types of defined contribution plans include:

• Individual Retirement Arrangements (IRAs);
  
  
• Roth IRAs;
  
  
• 401(k) Plans;
  
  
• 403(b) Plans;
  
  
• SIMPLE IRA Plans (Savings Incentive Match Plans for Employees);
  
  
• SEP Plans (Simplified Employee Pension);
  
  
• SARSEP Plans (Salary Reduction Simplified Employee Pension);
  
  
• Payroll Deduction IRAs;
  
  
• Profit-Sharing Plans;
  
  
• Money Purchase Plans;
  
  
• Employee Stock Ownership Plans (ESOPs);
  
  
• Governmental Plans;
  
  
• 457 Plans.

There are many types of QRP’s and each plan is designed to accomplish different employer’s and/or employee’s objectives. Assessing the options available through your employer or finding an independent retirement plan is a serious task and you need a solid understanding of the different types of plans and the situations in which those plans are most effective.

A retirement plan may have lots of benefits for you, your business and your employees. Retirement plans allow you to invest now for financial security when you and your employees retire. As a bonus, you and your employees get significant tax advantages and other incentives.

Business benefits usually include:

• Employer contributions are tax-deductible.
  
  
• Assets in the plan grow tax-free.
  
  
• Flexible plan options are available.
  
  
• Tax credits and other incentives for starting a plan may reduce costs.
  
  
• A retirement plan can attract and retain better employees, reducing new employee training costs.

Employee benefits include:

• Employee contributions can reduce current taxable income.
  
  
• Contributions and investment gains are not taxed until distributed.
  
  
• Contributions are easy to make through payroll deductions.
  
  
• Compounding interest over time allows small regular contributions to grow to significant retirement savings.
  
  
• Retirement assets can be carried from one employer to another.
  
  
• Saver’s Credit is available.
  
  
• Employee has an opportunity to improve financial security in retirement.

The main factor to consider for retirement revolves around financial independence achieved with enough savings, investment income, and/or pension income to cover your living expenses.

Our next newsletters will offer you more details on all of the retirement plans mentioned, so you can be better informed when you discuss with your financial advisor or tax professional about your “golden years”.

To make sure that your time of rest and relaxation will turn up the way you expect, you need to plan for retirement in advance. If you haven’t done so already, make sure you ask for professional help to enroll in the most suitable retirement plan for your particular situation as soon as possible.