there are two types of pension plans: defined benefit plans and defined contribution plans. A defined benefit plan promises participants a specified monthly benefit at retirement. The plan may state this promised benefit asan exact dollar amount, suchas $100 per month at retirement. Or, more commonly, it may calculate abenefit through a plan formula that considers such factors as salary and service -for example, 1 percent of average salary for the last 5 years of employment for every year of service with anemployer.
A defined contribution plan, on the other hand, does not promise a specific amount of benefits at retirement. In these plans, the participant or the employer (or both) contribute to the participant's individual account under the plan, sometimes at a set rate, such as 5 percent of their earningsannually. These contributions generally are invested on the participant's behalf. The participant 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 willfluctuate due to changes in the value of investments. Examples of defined contribution plans include 401(k) plans, 403(b) plans, employee stock ownership plans, and profit-sharing plans. The general rules of ERISA apply to each of thesetypes of plans, but some special rules also apply.
A money purchase pension plan is a plan that requires fixed annual contributions from an employer to a participant's individual account. Because a money purchase pension plan requires these regular contributions, the plan is subject to certain funding and other rules.
