A good retirement plan should be one that would provide retirees with the most benefits. These benefits should ideally provide tax advantages. Tax savings can be realized in the short run or in the long run depending on the type of scheme selected.
It should also provide a secure investment that offers attractive returns. This paper looks into the retirement programs highlighting the advantages of these schemes to different players. This paper opines that despite the few disadvantages of these schemes, They provide an great avenue through which employees can plan their futur.
These are a programs established by employer or employee or both aimed at providing the retirees with a source of income when they are no longer in employment.
Retirement plans basically are set up as a form of savings plan to cater for the future i.e. by providing some form of income when a person has retired.
Types of retirement plans
There are several retirement plans available in the market today. The employees should therefore select a plan that meets their expectation and suits their needs.
Below is a list and explanation of some of the available retirement plans.
i) Individual Retirement Accounts plans
It is one of the simplest retirement programs that can be set by an individual. It is also worthwhile to note that IRAs be established by employers.
Therefore IRAs can be established with little employers’ involvement to those that they establish and contribute to the scheme.
The retirement benefits depend on the contributions and subsequently the income earned by these funds.
There are four IRA plans
Payroll Deduction IRA- formed by the employee either under traditional or Roth IRA in conjunction with a financial institution.
The financial institution (banks, insurance companies) then deducts the contributions towards the plan under the authority of the employee.
Traditional IRA contributions are partly or wholly tax deductible and therefore present tax savings to the employee. The other advantage is that the earnings on the plan are not taxed unless distributed. The same applies to the contributions to the plan.
Roth IRA deductions are not tax deductible and also distributions are not part of the income (Internal Revenue Service 2008)
Salary Reduction Simplified Employee Pension Plan (SARSEP) – It is a simple plan that involves salary reduction agreement which enables the employers to contribute to the IRAs set by them and also to the employees IRAs. There contributions are subject to a limit.
Simplified Employee Pension Plan (SEP)-Employers contribute towards the plan
Savings Incentive Match Plan for Employees (SIMPLE IRA) – employers make contributions towards their own retirement plan and also that of the employees.
The employees reduce their salaries with the employers making similar contributions.
ii) IRC 401 (K) Plans.
Can involve employees delaying their salaries and these money is taken to 401(k) plan supported by their employers. The deferred salary is not taxed unless distributed.
The benefit of having a 401(k) plan is that one can have other plans as well
The employee/employer contribution is subject to a limit with withdrawals being permitted but subject to taxes.
iii) TRC 403(b)-Tax sheltered Annuity Plans
This plan are operated by public schools and certain tax exempt organizations.
This plan is same as 401(k) in the sense that contributions are in form of salary delays with the employers sponsoring the plan.
The potential benefits of this plan are that the contributions and earnings on retirement are tax deferred with annuities being carried by the employee on retirement or change of employers (IRS: 2008)
iv) IRC 457(b) Deferred Compensation Plans
Established by state or local government or tax exempt organization under IRA (501(c). Employees or employers contribute to the plan through salary reductions up to a certain set limit under IRC 402(g)
These plans can be eligible under IRC 457 (b) or illegible under IRC 457(f). Eligible plan allows tax deferral on contributions and earnings on the retirement funds (Ryterband &Alpem: 2005)
v) Designated Roth Accounts in 401(k) or 403(b) plans
401(k) and 403(b) can be designated as Roth plans since 2006. These plans are allowed under Code section 402 A added by the Economic Growth and Tax Relief Reconciliation Act 2001.
Designated Roth contributions are included in the gross income and are also elective. A designated Roth account is where with contributions is made with separate accounting of contributions, gains and losses being maintained (IRS 2008)
Designated Roth contributions are subject to limit with employee and employers contributing up to certain determinable limit.
Advantages and Disadvantages of good retirement plan
As discussed above, there are different types of retirement plans that employees and employers can chose from. The plan to be selected should provide the most benefits to both the employer and employee and most importantly suit the needs of both the employee and employers (Scotto, D., J et al: 2008)
Therefore, in discussing the advantages and disadvantages of retirement plans, it important to approach it from the employees and employers point view.
Tax saving-A good retirement plan should be able to provide the most tax savings and advantages. Tax advantages can be in the form of tax-exempt and tax deferrals.
A good number of retirement plans offer these tax advantages and therefore employees and employers can select a plan that meets their needs (Maddock J, 2007)
The tax savings can be realized in the short run or in the long run depending on the type of scheme selected.
Many investment options and opportunities-The contributions (funding) to the retirement plan are invested in various investment options. A good retirement plan should therefore put the money in investments that offer attractive returns while at the same time safeguarding the investor’s money.
Retirement plans are long term in nature and therefore the contributions should be invested in the long term also (Perlinger Financial Services: 2008)
Provides a ‘nest egg’-Retirement plans provide employees with an opportunity to slowly but constantly contribute towards their retirement. The benefit of this arrangement is that it does not strain the employees financially and thus they are able to make contribution which they are comfortable with.
All these contributions are invested in stocks, bonds and other investment opportunities which earn interest and appreciate in value and therefore the retirement benefits will accumulate and become substantial upon retirement.
Employer contributions-Contribution to the retirement benefits plan can be by an individual or by the company or both depending on the type of plan.
A good retirement benefit plan should allow both contribution of employee and employer. The employer contributions are usually elective in nature.
Contributions by both employer and employee ensure that the fund accumulates faster and thus on retirement the fund will be huge.
Performance of the fund-The contributors to the retirement scheme should be able to monitor the performance of the fund. A good retirement benefits plan should provide regular updates on the performance of the fund so that any surplus or deficit can be appropriately dealt with.
Employee retention-A good retirement plan can act as an incentive to the employees and also attract better employees. The company can retain its top employees by offering them a good retirement scheme and since it is for the long term, the company is able to retain them.
The company is also able to attract employees who are better qualified in terms of experience and skills and thus the company will benefit (Business Owners Toolkit: 2008)
Financial security of employees-Employees is able to perform optimally if they know that their financial future is guaranteed. A retirement benefit plan that provides this perceived financial security is good
Employee morale-Since most pension schemes are based on the salary earned by the employee, a good retirement plan therefore, serves to motivate and encourage all employees to work hard and hence earn more wages. Higher salaries subsequently means ‘handsome’ retirement package and this enhances staff morale.
Tax savings-The contributions to the retirement scheme in most plans is tax allowable and this provides the company with the most tax efficient way of rewarding its employees. The contributions are deducted when calculating the taxable income.
Reduced recruitment costs-As seen above, a good retirement plan helps the company retain most of its employees and therefore the costs associated with recruitment and replacing the employees who left the company is minimized (Perlinger Financial Services:2008)
Disadvantages of retirement plans
Despite all the numerous advantages of setting up a retirement plan, there are several disadvantages associated with it. Some of these are discussed below.
Some of the retirement plans are time consuming, expensive and complex to set up. The result of this is that the company incurs extra expenses and thereby squeezing the profit margins. The complexities in establishing the plan will also present more costs apart from being time consuming (Business Owners Toolkit: 2008)
The operations of the retirement plan needs professional expertise e.g. that of actuaries and accountant. These professionals offer their services at a fee which is usually expensive. The administrative costs of running a retirement plan may pose a challenge to the company in terms of extra costs.
Early retirement by the employee could reduce the amount received. This in essence means that the employee has to work his full employment term in order to receive all his retirement benefits. This could mean being trapped in employment even if one is not comfortable.
Joining a retirement plan late on in one’s employment i.e. when there are a few years till retirement may not accumulate a large amount enough to sustain the retiree. Therefore the retirement plan will not improve the financial security of the employee (Scotto, D., J et al: 2008)
In some of the retirement plans, the contributor has no role in deciding where to invest the fund’s money. This means that the money could be invested in assets that are not in line with one’s investment strategies. This essentially means that the contributor has no control of his money.
Employees are responsible for ensuring that they have enough savings for their retirement in some of the plans. This means that the employee is the one in charge of all the investment assets and therefore bears the responsibility of any losses incurred by these investments.
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