A pension scheme fund is established for final payment of post-retirement benefits. A scheme sponsor is the organization that sets up the pension scheme.

  • A private business organization on behalf of its employees is called a corporate plan or private plan.
  • A state, federal and local government on behalf of their employees called a public plan.
  • A union on behalf of its members called the Taft Hartley Plan.
  • An individual is called an Individually Sponsored Plan.

The two basic and widely used pension plans are defined benefit plans and defined contribution plans. In addition, a hybrid type of plan called a cash balance plan combines the features of both these pension plan types.

DB - In a defined benefit plan, the plan sponsor agrees to make specified dollar payments to eligible employees beginning at retirement. Effectively the DB plan pension liability is the debt liability of the plan sponsor. As a result the plan sponsor assumes the risk of having insufficient funds in the plan to meet regular contractual payments to currently retired employees as well as those employees who are required to make.

A plan sponsor has several options to decide who will manage the plan assets. The choices are:

  • Internal Management – Internal management is when the plan sponsor uses its own investment staff to manage the plan's assets.
  • External Management – The plan sponsor engages the services of one or more asset management companies to manage the assets of the plan.
  • Combination of internal and external management – Some of the assets in the plan are managed internally by the plan sponsor and the balance is managed by one or more asset management companies.

Asset managers who manage the assets of defined benefit plans are compensated in the form of management fees.

There are federal laws that regulate pension plans.

DC – In a defined contribution plan the plan sponsor is only responsible for making the defined contribution to the plan on behalf of the eligible participants. His contribution is often a percentage of the employee's salary. This organization does not guarantee any specific amount of money at the time of retirement of the plan sponsor. The amount that the employee will receive at the time of retirement is not guaranteed but instead depends on the growth of the plan assets. Plan sponsors offer plan participants a variety of options for investment vehicles in which they can invest. Defined contribution pension plans come in many legal forms: such as 401(k) plans, money purchase pension plans and ESOPs - employee stock ownership plans.

A hybrid pension plan is a combination of a defined benefit and a defined contribution plan, and the most common type is a cash balance plan. The plan defines future pension benefits, not employer contributions.

Retirement benefits are based on annual employer contributions of a fixed amount and a guaranteed minimum annual investment return. Each participant in a cash balance plan is credited with a dollar amount equal to the employer's contribution, usually determined as a percentage of wages. Each participant's account is also credited with interest linked to some fixed or variable index such as the CPI - Consumer Price Index. Usually a cash balance plan provides benefits in the form of a lump sum distribution like an annuity.

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