A retirement provides retirement INCOME to an employee or results in a deferral of income by employees during their EMPLOYMENT or beyond. It is a cash benefit created by government, the employer, or the employee to cover the period after the employee retires. In the United States, retirement plans include SOCIAL SECURITY (Old Age and Survivors Income), KEOGH PLANs, INDIVIDUAL RETIREMENT ACCOUNTs (IRAs), 401(K) PLANs and 403(b) and 457 plans. In most cases the employer governs the options available to employees. In some plans, employers determine whether the company pays all or part of the contributions; in other plans, employees determine contributions. The most popular and mandatory plan is Social Security, which was designed as a safety net for retired and disabled workers. President Franklin D. Roosevelt introduced the Social Security Act in 1935 as part of his New Deal legislation. In the United States today, over 90 percent retirees age 65 and older receive Social Security. In 2002 Social Security was funded through a payroll tax of 15.3 percent of wage income up to approximately $80,000, divided equally between employers and employees. Self-employed individuals pay both parts of the tax. By 2006 workers will have to be 66 years of age to receive full benefits, a figure that will rise gradually for future generations. IRAs are employee-controlled advisor-managed retirement plans. Created in 1974 under the EMPLOYEE RETIREMENT INCOME SECURITY ACT (ERISA), IRAs encourage employees to save and supplement Social Security benefits. Congress frequently changes IRA laws, but as of 2003 traditional IRAs allow workers and their spouses (subject to income limits) to contribute $3,000 each to their IRA accounts. These contributions are tax-deferred, meaning the amount is reduced from a worker’s current taxable income and taxes are paid when the individual withdraws the funds from his or her IRA account. Retirees can begin withdrawing at age 59½ and must begin withdrawing by age 70½. The penalty for early withdrawal of IRA funds is steep—10 percent of the amount withdrawn. Both the contributions to and the income generated from IRA INVESTMENTs are tax-deferred, providing greater returns than if the individual invested after-tax income. In the 1990s, Congress created so-called Roth IRAs (named after Senator William V. Roth Jr. of Delaware). Roth IRAs allow anyone to contribute up to $2,000 per year to an investment account, without income restrictions. The contribution is not tax deductible, but the income earned is tax-deferred until the funds are withdrawn. Self-employed individuals can create their own IRAs or Keogh retirement plans. Keogh plans, which are also sometimes called “qualified plans” or “H.R. 10 plans,” were named after U.S. Representative Eugene James Keogh and were first introduced in the 1960s. These plans offer significant benefits over traditional IRA plans for self-employed individuals and their employees. Like traditional IRAs, Keogh plans allow for contribution to a retirement account, and the worker’s contribution is pretax, which reduces his or her taxable income. This MONEY can be invested, and the interest from investments is tax-free until the money is withdrawn from the plan. There is an additional tax advantage to employers who receive a “dollar for dollar” tax write-off for any money contributed to an employee’s plan. The chief advantage of a Keogh plan over a traditional retirement account is the fact that it is possible to contribute more money annually. The amount of contribution possible depends on the Keogh plan chosen, but it is generally a maximum of $40,000 per year in 2002 (although this changes often due to legislation and INFLATION). Most CORPORATIONs in the United States offer retirement plans to their employees. A major distinction is whether the plan is a defined-benefit or defined-contribution. A defined-benefit plan is set up to give individuals a desired income upon retirement. Employees and their employers contribute to a retirement account, which is controlled by an employer-designated trustee. The employee has no input into how the funds are invested. At retirement, the employee receives a pension, usually based on a percentage of the employee’s income and years of service with the organization. The employee is usually given an option to take a lower monthly benefit and extend the payment over his/her life and the life of his/her spouse. With definedbenefit plans, employees who leave a company can leave their funds in the employer’s retirement plan, “roll over” their pensions into an IRA, or buy into the retirement plan offered by their new employer. In most U.S. corporations, defined-benefit plans have been replaced by defined-contribution plans. This transfers the RISK and responsibility for retirement income from the employer to the employee. It also allows employees to control their retirement funds as they move from one employer to another, in effect creating a portable retirement plan. Many times employers impose vesting requirements on their contributions to employees’ retirement plans. In 2002 employer restrictions prevented Enron employees from liquidating their holdings of Enron stock in their retirement plans, resulting in both the loss of their jobs and pension funds. Enron imposed a “blackout” period on employee access to their retirement funds just as the company’s financial problems were being exposed. The blackout had been announced in advance as the company was changing the plan administrator. Defined-contribution plans are known as the 400 plans (401(k), 403(b), and 457). Like defined-benefit plans and IRAs, contributions to 400 plans are tax-deferred. With defined-contribution plans, there are several ways that the money can be contributed. One option is the PROFIT SHARING plan, which allows employers to disburse a percentage of the firm’s profits to employees. Another option is a money-purchase plan in which the employer is required to contribute a set percentage of the employee’s compensation regardless of whether the company makes a profit or not. It is also possible to combine the profit-sharing and money-purchase options so that a portion is at the discretion of the employer and a portion is set. Many employers have set matching-contribution plans whereby the employer will match up to a set percentage of the employee’s income contributed to the plan.
See also SIMPLIFIED EMPLOYEE PENSION.