What is Corporate Pension Plan
A corporate pension plan is a formal arrangement between a company and its employees – or the employees' union – that provides funding for the employees' retirement. This pool of funds can be financed in several ways and will eventually be used to make periodic payments to retired employees. In most cases, both employer and employees make regular contributions to the plan. In the past, employers were wholly responsible for contributing to the plan based on an employee's work, length of employment and position held.
BREAKING DOWN Corporate Pension Plan
Two of the most common corporate pension plans are the defined-benefit and defined-contribution plans.
Defined-Benefit Corporate Pension Plans
With defined-benefit plans, employee retirement benefits are calculated according to a formula that takes into account the duration of employment and salary history. It is the employer's responsibility to come up with the necessary cash to fund the plan.
When participating in a defined-benefit pension plan, an employer promises to pay employees a specific benefit for life beginning at retirement. The benefit is calculated in advance, using a formula based on age, earnings, and years of service. In the United States, the maximum retirement benefit permitted under a defined benefit plan as of October, 2017, is $220,000. Defined benefit pension plans in the U.S. currently do not have contribution limits.
The liability of a defined-benefit pension lies with the employer, who is responsible for making all decisions regarding the fund. Employer and employee contributions to a defined benefit pension plan are based on a formula that calculates the contributions needed to meet the defined benefit. These contributions are actuarially determined, taking into consideration the employee's life expectancy and normal retirement age, possible changes to interest rates, annual retirement benefit amount and the potential for employee turnover.
Defined-Contribution Corporate Pension Plans
Defined-contribution plans, on the other hand, don't guarantee a certain benefit. Fixed contributions are paid into an individual account by employers and employees. The contributions are then invested, for example in the stock market, and the returns on the investment (which may be positive or negative) are credited to the individual's account. The payout from this plan rests solely on the success of the investments made for the pension plan.
On retirement, the member's account is used to provide retirement benefits, usually through an annuity, which then provides a regular income. Defined contribution plans have become widespread all over the world in recent years and are now the dominant form of plan in the private sector in many countries. The number of defined contribution plans in the U.S. has been steadily increasing, as more and more employers see pension contributions as a large expense avoidable by disbanding the defined benefit plan and instead offering a defined contribution plan.