Pension plan is yet another type of insurance that allows one to get guaranteed income after their retirement. The plans vary greatly in terms of their structure as well as their benefit. There are two common types of retirement or pension plan. The first one is known as the money purchase plan and the defined benefit plan. Sometimes the two plans are combined together to form a Hybrid retirement plan.
Defined Benefit Plans are meant to offer a definite amount of pension to a person after its retirement from his office whereas in money purchase plan, a fixed amount of money is contributed on a regular basis in an investment account of the policy holder. At the time of retirement, the investments as well as the interests are used to buy pension.
Three types of formulas are mainly used by the insurance companies of today namely, Flat benefit formulae, Final or best average earning formula and Career average-earning formula.
• Flat benefit formula – in this case the yearly pension of an individual would be a specific amount that can be drawn in every year.
• In case of Final or best average earning formula, the pension is adjusted as per the wages. This formula offers a specified percentage of the final earnings of a person for every year of his or her service.
• In Career average-earning formula, the annual pension benefit would be the fixed percentage of one’s annual earnings.
There are certain pension plans that allow an individual to make their own choice of investment and in some other cases the decision is taken by the board of trustees of an organization. There is also the Individual pension plan that is designed mainly for the people in the higher income slab and is known to offer huge tax deductions.