A pension plan is a retirement plan that requires an employer to make contributions to a pool of funds set aside for a worker’s future benefit. The pool of funds is invested on the employee’s behalf, and the earnings on the investments generate income to the worker upon retirement.
In addition to an employer’s required contributions, some pension plans have a voluntary or contributory investment component. A pension plan may allow a worker to contribute part of his current income from wages into an investment plan to help fund retirement. The employer may also match a portion of the worker’s annual contributions, up to a specific percentage or amount.
Main Types of Pension Plan
There are two main types of pension plans the defined-benefit and the defined-contribution plans.
Defined-Benefit Plans
In a defined-benefit plan, the employer guarantees that the employee receives a definite amount of benefit upon retirement, regardless of the performance of the underlying investment pool. The employer is liable for a specific flow of pension payments to the retiree (the dollar amount is typically determined by a formula, usually based on earnings and years of service), and if the assets in the pension plan are not sufficient to pay the benefits, the company is liable for the remainder of the payment.
Defined-Contribution Plans
In a defined-contribution plan, the employer makes specific plan contributions for the worker, usually matching to varying degrees the contributions made by the employees. The final benefit received by the employee depends on the plan’s investment performance. The company’s liability to pay a specific benefit ends when the contributions are made.
Because this is much less expensive than the traditional pension, when the company is on the hook for whatever the fund can’t generate, a growing number of private companies are moving to this type of plan and ending defined-benefit plans. The best-known defined-contribution plan in Nigeria is the CPS Contributory Pension Scheme
Source: Investopedia
