Retirement Plan Design Flashcards

What is the purpose of a defined benefit plan?

Answer: To guarantee retirement income

A defined benefit plan, often called a pension, promises a specific monthly payment to retirees for the rest of their lives. The employer bears the investment risk and is responsible for funding the plan to ensure these guaranteed payments. This provides a predictable and stable income stream in retirement.

Which plan type allows employee salary deferral?

Answer: 401(k) plan

A 401(k) plan is a defined contribution retirement plan that allows employees to contribute a portion of their pre-tax salary directly from their paycheck. This "salary deferral" reduces their current taxable income. Employers often offer matching contributions, further incentivizing participation and boosting retirement savings.

What is a vesting schedule?

Answer: Ownership timeline for employer contributions

A vesting schedule dictates when an employee gains full ownership of employer contributions made to their retirement plan, such as a 401(k). Until contributions are fully vested, an employee might forfeit some or all of them if they leave the company. This encourages employee retention and ensures employees earn their benefits over time.

Which plan allows employers to contribute a fixed percentage of salary?

Answer: Money purchase pension plan

A money purchase pension plan is a type of defined contribution plan where the employer is required to contribute a fixed percentage of each employee's salary annually. Unlike profit-sharing plans, these contributions are mandatory regardless of company profits. This provides a consistent and predictable contribution for employees' retirement savings.

What is a common feature of defined contribution plans?

Answer: Fixed contributions, uncertain benefit

Defined contribution plans, such as 401(k)s and 403(b)s, are characterized by fixed contributions made by the employee and/or employer. However, the ultimate retirement benefit is not guaranteed; it depends on the investment performance of these contributions over time. The employee typically bears the investment risk.

What plan is commonly used by nonprofit organizations?

Answer: 403(b)

A 403(b) plan is a retirement savings plan specifically designed for employees of public schools and certain tax-exempt organizations, such as hospitals and charities (nonprofit organizations). It operates similarly to a 401(k) but is tailored to the unique needs and regulations of these types of employers. It allows for pre-tax contributions and tax-deferred growth.

What is a key benefit of automatic enrollment in retirement plans?

Answer: Encourages employee participation

Automatic enrollment in retirement plans means employees are automatically signed up to contribute a portion of their salary unless they actively opt out. This significantly increases participation rates, especially among younger or lower-income employees, helping more people save for retirement. It leverages inertia to overcome procrastination in financial planning.

Which agency insures defined benefit pension plans?

Answer: PBGC

The Pension Benefit Guaranty Corporation (PBGC) is a U.S. government agency that insures the retirement incomes of over 33 million American workers and retirees in defined benefit pension plans. If a company's defined benefit plan fails, the PBGC steps in to pay a portion of the promised benefits, providing a safety net for retirees.

What type of plan provides a lump sum at retirement?

Answer: Defined contribution plan

Defined contribution plans, such as 401(k)s, accumulate funds over an employee's working career based on contributions and investment growth. At retirement, the employee typically receives the accumulated balance as a lump sum, which they can then manage, roll over, or use to purchase an annuity. The benefit is not a guaranteed monthly payment but rather the total value of the account.