Legal Definitions - retirement plan

A retirement plan is a written employee benefit plan that provides retirement benefits to employees, officers, and advisers of a company. It can be a stock-purchase, savings, option, bonus, stock-appreciation, profit-sharing, thrift, incentive, pension, or similar plan. Retirement plans can be divided into two types: defined-benefit plans and defined-contribution plans.

A defined-benefit plan is a retirement plan that provides systematically for the payment of definitely determinable benefits to employees over a period of years, usually for life, after retirement. Retirement benefits under a defined-benefit plan are generally based on a formula that includes factors such as years of service and compensation. If the trust funding the plan lacks sufficient assets to pay the promised benefits, the employer is required to cover the shortfall.

Example: A company's retirement plan promises to pay its employees 60% of their average salary for the last five years of employment for every year of service. If an employee works for the company for 30 years and retires with an average salary of $100,000, they will receive $180,000 per year in retirement benefits.

A defined-contribution plan is a retirement plan in which each participant has a separate account funded by the employee's contributions and the employer's contributions. Each participant's benefits are based solely on what has accumulated in the participant's account. The most common type of defined-contribution plan is a 401(k) plan.

Example: A company's 401(k) plan allows employees to contribute a portion of their pretax salary to the plan, and the employer matches a percentage of the employee's contributions. The employee can choose investments from a list of options. At retirement, the employee's retirement benefits are based on the amount accumulated in their account.

Other types of retirement plans include:

• Employee-stock-ownership plan (ESOP): A type of profit-sharing plan that invests primarily in the employer's stock.
• Disability retirement plan: A plan that is invoked when a covered person is disabled from working to normal retirement age or provides increased benefits if a person retires because of a disability.
• Money-purchase plan: A defined-contribution plan that provides for mandatory employer contributions without regard to employer profits.
• Nonqualified deferred-compensation plan: An unfunded compensation arrangement that defers compensation and the recognition of its accompanying taxable income to a later date.
• SIMPLE plan: An arrangement under which an individual retirement account or annuity is established for each eligible employee and funded by elective pretax employee contributions, much as with a 401(k) plan, and certain matching or minimum employer contributions.
• Simplified employee pension plan (SEP): An arrangement under which an individual retirement account or annuity is established for each eligible employee and funded by discretionary employer contributions.