Page 181 - Group Insurance and Retirement Benefit IC 83 E- Book

Chapter 10: Taxation Treatment of provisions for Retirement Benefits-
II:

A retirement plan is a financial arrangement designed to replace employment income

upon retirement. These plans may be set up by employers, insurance companies, trade
unions, the government, or other institutions. Congress has expressed a desire to

encourage responsible retirement planning by granting favorable tax treatment to a wide

variety of plans. Retirement plans in the U.S. are defined in tax terms by the IRS code
and are regulated by the Department of Labor's provisions under the Employee

Retirement Income Security Act.

Retirement plans are classified as defined benefit or defined contribution according to

how benefits are determined. A defined benefit (or pension) plan calculates benefits using

a fixed formula that typically factors in final pay and service with an employer, and
payments are made from a trust fund specifically dedicated to the plan. In a defined

contribution plan, the payout is dependent upon both the amount of money contributed
into an individual account and the performance of the investment vehicles utilized.

Some types of retirement plans, such as cash balance plans, combine features of both
defined benefit and defined contribution schemes.

Defined contribution plan

According to the Internal Revenue Code Section 414, a defined contribution plan is an
employer-sponsored plan with an individual account for each participant. The accrued

benefit from such a plan is solely attributable to contributions made into an individual

account and investment gains on those funds, less any losses and expense charges. The
contributions are invested (e.g., in the stock market), and the returns on the investment

are credited to or deducted from the individual's account. Upon retirement, the
participant's account is used to provide retirement benefits, often through the purchase of

an annuity. Defined contribution plan have become more widespread over recent years
and are now the dominant form of plan in the private sector. The number of defined

benefit plans in the US has been steadily declining, as more employers see pension