A retirement plan makes up for the regular income that is earned during employment. The government, insurance companies, trade unions and of course employers offer different types of retirement plans. Basically, these plans are twofold: 1) defined benefit plans and 2) defined contribution plans.

Defined contribution plans

Here, the payout to the retiree will depend on his/her contributions to the retirement plan and returns on the investments made through this plan. For instance, the contributions made by the member are deposited to an individual account and they can be invested in the stock market or anywhere else. Returns on these investments will also be directed to the account. When the member retires, benefits will be offered through the retirement account.

It’s clear that this type of retirement plan is more favorable to profit-based companies as the payout will be affected by the member’s contributions and the performance of investments made through his/her account. This is the most common form of retirement plan in the world today and is preferred over the defined benefit plans, particularly by private companies. Individual retirement accounts (IRAs) and the 401(k) scheme fall under this category.

To members of such plans, the advantages range from being able to select his/her plan of investment to receiving tax cuts. In some plans of this type, the employer matches contributions made by the employee/member, giving another advantage to the account holder. Funds in these accounts can only be withdrawn when the account holder reaches a specific age.

Defined benefit plans

In this scheme, a specific payment is guaranteed at retirement. This amount is derived through a fixed formula which is based on the applicant’s salary and the number of years he/she has been with the plan.

Traditionally, pensions were paid based on the numbers of years of service or work. This number is multiplied by the salary at retirement and by a constant factor. The total amount calculated this way would be paid out as a lump sum or monthly pension. New forms of defined benefit plans are also based on this core concept. A present day example of a defined benefit plan offered by the government is Social Security.

Hybrid plans

These are plan that have qualities similar to both defined benefit plans and defined contribution plans. The target benefit plans and cash balance plans are examples under this category but these are not very popular options.