A pension plan is a type of retirement savings account that some employers may provide as a long-term benefit. In most cases, pension plans are set up on behalf of the employee by the organization. A business will typically choose an investment firm to oversee its pension plan account and handle individual distributions to retirees. Contributory plans work similar to a 401(k) — both the employee and the employer have the option of making monthly contributions. The deposits made to a noncontributory plan originate exclusively from the employer.
Enrollment in a noncontributory pension plan typically begins with employment and is often nonvoluntary. Most organizations that provide a noncontributory pension plan benefit automatically calculate an expected benefit based on an employee's annual salary and tenure. Contributory plans may require the employee to enroll in the plan if he wishes to set aside a portion of his monthly salary. Some types of organizations, including those funded by tax revenues, may require full-time employees to participate in a contributory pension plan.
Noncontributory pension plans do not typically deposit monthly contributions to an employee's account. These types of plans calculate an expected future income benefit based on the employee's job classification, salary and years of service. The plan uses a percentage of the employee's annual income to determine the benefit amount. Contributory pension plans withdraw a percentage of the employee's gross income on a monthly basis and deposits these amounts into an investment fund. The percentage the employee contributes may vary.
Both contributory and noncontributory pension plans require the employee to accumulate a certain number of service years with the company. Company pension plans often refer to this minimum length of service as vesting. If an employee terminates his employment prior to being vested, he may be ineligible to receive benefits. A typical vesting period is five years, which means employees who accumulate five or more years of continuous service will receive a payout from the plan. Contributory plans that require employees to deposit a percentage of their monthly income typically have a provision that allows employee contributions to be vested from day one.
Contributory pension plans may impose annual contribution limits on employees. According to the University of Chicago, the 2012 federal limit for contributions to pension and supplemental retirement plans was $50,000 combined. Federal limits also restrict employers and employees from making contributions on annual income that exceeds $250,000. Employers and employees may contribute a percentage of annual income up to the annual income limit. For example, an employee who makes $260,000 may contribute 8 percent of $250,000, but may not set aside a percentage of the remaining $10,000. Contribution limits for noncontributory plans are usually determined by the employer and may be adjusted or reduced if the employee decides to retire before age 65.
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