Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Pension Plan

What it is:

A pension plan is an arrangement to provide employees with an income when they are no longer earning a regular income from employment.

How it works (Example):

A pension plan is usually a type of retirement plan that gives employers the opportunity to make a contribution to a fund set aside for an employee's future benefit.  The pool of funds is invested on behalf of the employee, on a tax exempt basis, and is intended to yield a stream of payments to the employee upon retirement.

By allowing the employer to make the payment into the employee's pension plan in this way, the employee is deferring a portion of his or her income to a future time.
  
There are two main types of pension plans.  One type is defined-benefit plans, where the employee receives a specific amount upon retirement regardless of the performance of the investment pool.  The other type is a defined-contribution plan, where the employee receives an amount based on the performance of the investment pool.

In accordance with the US Internal Revenue Service code, the amount of the tax-exempt contributions into a pension plan is limited based on the income levels of the employee. 

Why it Matters:

Pension plans can include a variety of types of contributions in addition to cash payments.  For example, a pension plan may include profit-sharing plan, a stock bonus plan (usually deferred until retirement so that the contribution is taxed at the retirement tax rate) and even an employee stock ownership plan.