DEFINED CONTRIBUTION PLANS A defined contribution plan specifies how much money will go into aretirement plan today. The amount typically is either a percentage of anemployee’s salary or a specific dollar amount. Those funds often are investedin mutual funds or annuities available inside the retirement plan. The amountyou have at retirement depends on how much (fi anything) your employercontributes to the plan, how much you as the employee save in the plan, howlong you leave those funds invested, and how well your investments performinside the plan.More and more employers are replacing defined benefit plans withdefined contribution plans, primarily due to the expense and long-termobligations associated with running a defined benefit plan. If you have adefined benefit plan through your employer, be sure to regularly let youremployer know that you really appreciate your retirement plan; it’s a benefitwell worth keeping.
INDIA – DEFINED CONTRIBUTION PLANCentral Government employees in India who joined after January 1, 2006participate in National Pension Scheme which is defined contribution plan run by Pension Fund Regulatory Authority of India. Earlier employees were under Defined Benefit Plan.AllGovernment and Private sector organizations had to offer Provident Fund (PF)which is a type of Defined Contribution Plan.
The NPS which was started in 2006is a recent option given to all Central Government employees. The % ofcontribution made by the employer and employees are mandated by theregulations. Additionally employees are given the ability to opt for anadditional contribution if they so desire. All contributions are managed by thePF authority.
PF authority choose the investment vehicle, however thebeneficiaries are given a standard % of returns on their contribution.Some large private sector organizations have also formed their Trust to managethe contributions received from its employees. DEFINED CONTRIBUTION PENSION SCHEME INDIA The New Pension Schemeworks on defined contribution basis and will have two tiers Tier-I and II. Contribution to Tier-I ismandatory for all Government servants joining Government service on or after1-1-2004 (except the armed forces in the first stage), whereas Tier-II will beoptional and at the discretion of Government servants.1.
In Tier-I, a Government servant will have tomake a contribution of 10% of his basic pay plus DA, which will be deductedfrom his salary bill every month by the PAO concerned. The Government will makean equal matching contribution. However, there will be no contribution from theGovernment in respect of individuals who are not Government employees.
Tier-I contributions (andthe investment returns) will be kept in a non-withdrawable Pension Tier-IAccount. Tier-II contributions will be kept in a separate account that will bewithdrawable at the option of the Government servant. Government will not makeany contribution to Tier-II account.
The existing provisionsof Defined Benefit Pension and GPF would not be available to the new recruitsin the central Government service, i.e. to the Government servants joiningGovernment service on or after 1-1-2004.In order to implement theScheme, there will be a Central Record Keeping Agency (CRA) and several PensionFund Managers (PFM) to offer three categories of Schemes to Governmentservants, viz., options A,B and C based on the ratio of investment in fixedincome instruments and equities. The participating entities (PFMs and CRA)would give out easily understood information about past performance, so thatthe individual would be able to make informed choices about which scheme tochoose.An independent PensionFund Regulatory and Development Authority (PFRDA) will regulate and develop thepension market.
As an interimarrangement, till such time the Statutory PFRDA is set up, an interim PFRDA hasbeen appointed by issuing an executive order by M/o Finance (DEA).Till the regular CentralRecord Keeping Agency and Pension Fund Managers are appointed and theaccumulated balances under each individual account are transferred to them,such amounts representing the contributions made by the Government servants andthe matching contribution made by the Government will be kept in the PublicAccount of India. This will be purely a temporary arrangement as announced bythe Government.· Tier-II will not be made operative during theinterim period.· A Government servant can exit at or after theage of 60 years from the Tier-I of the Scheme. At exit, it would be mandatoryfor him to invest 40 per cent of pension wealth to purchase an annuity (from anIRDA-regulated Life Insurance Company) which will provide for pension for thelifetime of the employee and his dependent parents/spouse. He would receive alump-sum of the remaining pension wealth which he would be free to utilize inany manner. In the case of Government servants who leave the Scheme beforeattaining the age of 60, the mandatory annuitization would be 80% of thepension wealth.
EMPLOYEES’ PROVIDENT FUNDUnder the definedcontribution plan contribution of employer and employee is defined. This planseeks and runs on the contribution as per agreement and makes available theaccumulated balance at the end of period. These plans have offered bettertransparency and portability to employees and employer to meet the change incorporate world. Employees’ Provident Fund and MiscellaneousProvisions Act,1952 Applicable to whom?· Every establishment which is a factory and 20or more persons employed. · Any other establishment with more than 20employees.
· Other establishment as the central Governmentmay notifyEmployee Eligibility:· Employed through a contractor· Engaged as an apprentice, not being anapprentice engaged under the Apprentice Act, 1961Once the Act applies toany establishment, it continues to apply even if the number of employees workingthere falls below 20 thereEmployee Coverage:The scheme excludes anyemployee who is:· A casual employee· An employee whose pay is more than Rs. 6500per month· An employee who is drawing pay of more thanRs. 6500 can become member with permission of Assistant PF Commissioner.· A person who is already a member continues tobe a ‘member’ even if his pay exceeds Rs. 6500.Contribution:· The employee contributes 12% of· Basic wages + DA + Cash value of any foodconcession + Retaining allowance· Retaining Allowance: Allowance paid to anemployee for retaining his service when establishment is not working· The rate of contribution is 10% in case ofcertain establishment like sick industrial company etc Allocation of Contribution: Interest:· The interest is credited to member’s account onmonthly running balance basis· Currently the rate of interest is 8.5%· The interest rate is declared every yearduring March/April by central Government in consultation with Central Board ofTrustees of PFTaxability:· Employee’s contribution is allowed u/s 80C· Employer’s contribution is excess of 12% formsa part in gross salary· Interest up to 8.
5% is exempt from tax· Any excess interest above such limit forms a part in gross salary Withdrawal:Amount can be withdrawnin full· On retirement· On retirement on account of permanentincapacity to work· Immediately before migration from India forpermanent settlement· On termination of service in case of mass orindividual retrenchment· On VRS· After 2 months of resignation, in case of noemploymentAdvance from the Fund:· Purchase of dwelling site· Construction of dwelling house· Buying of dwelling house· For illness of member of his family· For marriage· Property damage due to natural calamity etc.How does defined contributionplan work?All defined contribution plans basically work thesame way. You decide how much you want to contribute, and your employer putsthe money into your individual account on your behalf. The investment happensthrough payroll deduction: You decide what percentage of your salary you’d liketo contribute and, from then on, that amount comes straight out of yourpaycheck and goes into your account automatically, without you having to lift afinger. Your paycheck will be smaller as a result – though not as small as youmight think, thanks to the tax benefits involved. You decide what you want the money in your plan tobe invested in. Your employer’s plan will have a limited selection ofinvestments for you to choose from.
When you leave your job, you still maintainownership over your account. Many employers also agree to kick in some of theirown money once you’ve decided to put your money in. This is known as a matching contribution. Many employers kick in 50 cents for every dollaryou contribute, up to a certain percentage of your salary (perhaps 3% to 6%).So, if over the course of the year you contribute $3,000, your company wouldput in $1,500. Types ofdefined contribution plans 401(k)s andsimilar plans – 403(b)s, 457s and Thrift Savings Plans – are ways to save for your retirement thatyour employer provides, or “sponsors.” You may hear people describethem as “defined contribution plans.
” That name comes from the factthat you make contributions to the plans -that is, you put your own money into them. (You may also hear your employerdescribe the plan simply as “The Company X Savings Plan.”) Here’s how they break down: · 401(k)sare the version that corporations offer to their employees. (Roth 401(k)s area subgroup that has different tax treatment.)· 403(b)sare for employees of public education entities and most other nonprofitorganizations.· 457s arefor state and municipal employees, as well as employees of qualifiednonprofits.
· ThriftSavings Plans (TSPs) are for federal employees.401(k) plans are the most common type of definedcontribution plan, so they’re what you may read and hear about most often. Butin fact there are no huge differences between a 401(k) plan and the otherdefined contribution plans (beyond who can use them, of course). What is 401(K) plan?A 401(k) plan is a retirement plan offered to youthrough your employer.
401(k)s are the most common kind of defined contribution retirement plan. Here’s how it works: You decide how much you wantto contribute, and your employer puts the money into your individual account onyour behalf. The investment happens through payroll deduction: You decide whatpercentage of your salary you’d like to contribute and, from then on, thatamount comes straight out of your paycheck and goes into your accountautomatically, without you having to lift a finger. Your paycheck will besmaller as a result – though not as small as you might think, thanks tothe tax benefits involved. Your company serves as the “plan sponsor”for the 401(k), but it doesn’t have anything to do with investing the money.Instead, the plan sponsor hires another company to administer the plan and itsinvestments.
The plan administrator may be a mutual fund company (such asFidelity, Vanguard or T. Rowe Price), a brokerage firm (such as Schwab orMerrill Lynch) or even an insurance company (such as Prudential or MetLife). Your employer sends your payroll deductionsdirectly to the company managing your plan. But you are responsible fordeciding how to invest your money among the options offered by your plan.Typically, a 401(k) offers five or more mutual funds thatinvest in various sectors of the financial markets.
Some 401(k) plans alsooffer shares of your employer’s stock What isthe tax benefit through 401(k) plan? You fund 401(k)s (andother types of defined contribution plans) with “pretax” dollars,meaning your contributions are taken from your paycheck before taxes arededucted. That means that if you funda 401(k), you lower the amount of income you have to pay taxes on, which cansoften the blow to your take-home pay. For example, if you put $100 into your401(k) each month, your paychecks might only get smaller by about $60-$80 permonth. (The exact amount will vary depending on your salary and tax bracket.) So if you make a small contribution to a 401(k), orif you increase your contribution by 1% or so a year, chances are you’ll hardlyeven notice the difference in your pay checks, and your tax bill will be lower.You will have to pay taxes eventually of course, but not until you retire. TheIRS taxes all withdrawals at your ordinary income tax rate.
But there’s acatch: if you make withdrawals before age 59 ½, you typically have to pay a 10%early withdrawal penalty on top of any taxes due. That can take a huge chunkout of your nest egg, and is usually a bad idea. There’s also a type of 401(k) plan called the Roth 401(k), whichoffers a tax break that essentially acts as the reverse of the traditional 401(k): You do have to pay tax on your contributions, but you won’t have topay any tax when you withdraw the money in retirement. So all the money in youraccount grows tax free. How muchcan we contribute to 401(k) plan Given the plans’ valuable tax breaks, it makessense to invest the maximum if you can. There are annual limits. In 2016, ifyou are under 50 years old, you can contribute a maximum of $18,000. If you’re50 or older, you can make an additional catch-up contribution of as much as$6,000, for a total of up to $24,000.
Those contribution limits change annuallyto track inflation. The reason: Inflation will gradually reduce the value of adollar, meaning you will need to contribute more dollars to have the samepurchasing power. Try to contribute at least enough to qualify foryour company’s maximum matching contribution. Research shows that about onequarter of 401(k) participants don’t contribute enough to qualify for themaximum matching contribution from their employer. Your Human Resourcesdepartment can tell you how much you need to contribute in order to get thegreatest match. Do it! Matchingcontribution Lots of defined contribution plans come with abonus: a matching contribution from your company.
The match can often be 50cents to a dollar for every dollar you contribute, up to a set maximum -perhaps 3% to 6% of your salary, or in some cases a dollar limit. The match isfree money! And it effectively increases your income without increasing yourtax bill, since you pay no taxes on matching contributions until you withdrawthem in retirement.The employer’s match money typically”vests” over three or four years, meaning you have to keep workingfor the company for that amount of time before all the matching funds are yoursto keep. Differencebetween 401(k) and Roth 401(k) plans Roth 401(k) is a relatively new option that someemployers offer along with a traditional 401(k). It’s basically the opposite of a traditional 401(k) plan – meaning youpay the taxes on your contributions, but not your withdrawals. So while you dohave to fund it with after-tax dollars, the money grows tax free and you won’thave to pay income tax on any money you take out. Roth 401(k)s are subject to required minimumdistribution rules.
So after you turn 70 ½, you will be required to start withdrawingmoney from the account. If your employer offers both types of plans, you candivide your savings among them – they will have the same investment options -but your combined annual contributions cannot exceed $18,000 in 2016 ($24,000for people 50 or older). What is403(b) plan? A 403(b) plan is a kind of defined contribution retirement plan. It may be offered to employees of government andtax-exempt groups, such as schools, hospitals and churches.
Employees who are eligible can defer money fromtheir paychecks into their 403(b) accounts, which work the same as way as 401(k) plans. 403(b)plans are also sometimes offered as Roth versions. The main difference is the type of employers whocan offer them. Unlike 401(k) plans whichare offered by for-profit companies, 403(b) plans are only available toemployees of tax-exempt organizations.
These are usually either schools,hospitals or religious groups. The names simply refer to the section of the taxcode that outlines these plans.For the most part, the two types of plans work thesame way. While 403(b) plans historically offered more limited investmentchoices than corporate plans, they’ve recently begun offering a broader arrayof investment options. And while 401(k)s frequently have vesting schedulesspread out over a few years, many 403(b)s vest immediately, or over a shorterperiod of time than in their cousins in the for-profit world.
You can contribute a maximum of $18,000 in 2016 ifyou are younger than 50 years old. If you are 50 or older, you can make anadditional catch-up contribution of as much as $6,000, for a total of up to$24,000. Those contribution limits are scheduled to adjust annually in linewith inflation. Employees who have worked for the same nonprofitfor 15 years may also have access to an additional “catch up provision” of$3,000 per year for up to five years, if they contributed an average of lessthan $5,000 per year previously.
When investingfor a long-term goal such as retirement, you typically want to emphasizestocks, which have the best chance to generate returns that outpace inflation.Adding some bonds or cash to your mix can help reduce your investments’ overallvolatility. See the Investing section for more on investment strategies.
You can also use our asset allocator and retirement planner calculators to determine the best mix of stocks, bonds andcash for your retirement money. What is a457 plan? A 457 plan is a kind of defined contribution retirement plan available to state and local publicemployees, but can also be offered by certain nonprofit organizations. Theywork much the same way as 401(k) plans: you canopt to divert part of your salary into the plan, and the money is automaticallydeducted from your paycheck before taxes are taken out. The money growstax-deferred until it’s withdrawn, and then Uncle Sam comes calling.
However, there are differences in the maximumannual contribution limits and the treatment of early withdrawals. If the 457 plan is the only one your employeroffers, the limits are the same as with a 401(k) – a maximum of $18,000 in 2016for those under 50 years old, and up to $24,000 for those 50 and over. But here’s the difference: If your employer alsooffers a 401(k) or 403(b) plan, you can contribute to both the 457 and the other plan.
Moreover, you caninvest up to the maximum in each account. In2016, the limits are $18,000 in each type of account, plus catch-upcontributions – so you could make a total retirement contribution of as much as$36,000 (or $48,000 if you are 50 or older). Investing the max in both isa terrific option if you’re getting started saving a little late, or you justwant to maximize the advantages of these plans (tax breaks and matching, ifany). Even if you’re not eligible for another plan,special 457(b) has additional catch up provisions in for workers three yearsfrom the retirement age (as specified by their plan) to stash an additional$36,000 if you haven’t maxed out your retirement savings in previous years.
What isThrift savings plan? The Thrift Savings Plan, or TSP, is a kind of defined contribution retirement plan for employees of the federal government,including members of the uniformed services (Army, Navy, Air Force, MarineCorps, Coast Guard, Public Health Service, and the National Oceanic andAtmospheric Administration, including the Ready Reserve or National Guard ofthose services.) They work much the same way as 401(k) plans: you canopt to divert part of your salary into the plan, and the money is automaticallydeducted from your paycheck before taxes are taken out. The money growstax-deferred until it’s withdrawn, and then Uncle Sam comes calling. How muchcan I contribute to thrift savings plan? You cancontribute a maximum of $18,000 in 2016 if you are younger than 50 years old.If you are 50 or older, you can make an additional catch-up contribution of asmuch as $6,000, for a total of up to $24,000. Those contribution limits arescheduled to adjust annually in line with inflation. Advantages of defined contribution planThe defined contribution planhas become the retirement plan of choice for many businesses andindividuals instead of the defined benefit plan. With this type of plan, youdecide how much you want to contribute instead of how much you will receive atthe end.
Here are afew of the advantages of using this type of retirement plan.1.ControlOne of the biggest advantages ofusing a defined contribution plan is that you have more control over theprocess. You can decide how much you want to set aside for your retirement andyou can also make decisions about the investments. With this type of plan, youget to choose what types of investments you put your money into.
You decidewhen to buy and sell shares and how risky you want to be. With a definedbenefit plan, you do not have any control over what happens to your money. Apension manager will be in charge of the funds and they will choose theinvestments for everyone.2.PortabilityAnother advantage of puttingmoney into this type of retirement plan is that it is portable. This means thatyou can easily take the money with you when you move to another company orbecome self-employed.
For example, if you have money in a 401k with youremployer, you can simply roll the money into an IRA when you quit your job. Ifyou start up with another employer that has a 401k, you can easily roll thefunds into that account and continue saving for retirement. This makes it amuch simpler process than when you are a part of a defined benefit plan.3. EqualBenefitsWith a defined contribution plan,you will also be able to get benefits that are equal for everyone.
With adefined benefit plan, this may not be the case. Many defined benefit plans onlyprovide any type of benefit for those that have been employed at the companyfor 10 years or longer. The vesting requirements of a defined benefit plan aregenerally much more difficult than those of a defined contribution plan. With adefined contribution plan, you will be able to gain access to the benefits muchsooner. As soon as you are eligible to start contributing to the plan, you canstart saving for your retirement.4.
HigherPotentialWith a defined contribution plan,you can potentially have more money available for you during retirement. Whenyou put money into a defined contribution plan, you can choose the investmentsfor yourself and if they perform well, you will be rewarded. With a definedbenefit plan, you have a ceiling on what you can get for retirement. Everyonereceives a certain amount of money for a certain number of years of service forthe company.
If the retirement benefits are not that high, it can bedisheartening because you know exactly how much you are going to get uponretirement.