What is the method of calculating monthly pension as per EPFO pension fund scheme?

by adam456 Sat Nov 26, 2011 7:29 am

I was member of the Family Pension Fund scheme, under the old scheme from 1985 to 1995 (10years) then continuing under the new scheme from 1995 to 2003 (8years).
My basic salary at the time of leaving service was Rs.13000.
I have been unemployed since 2003.
I have now reached the age of 58.
How will my pension be calculated under the family pension scheme rules?
If any one has any knowledge of this please help.

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Annuities

by Guest Fri May 25, 2012 4:57 pm

Pension

This article is about the retirement income arrangement. For the type of lodging, see Pension (lodging). For the mortgage repayment scheme, see Mortgage loan.
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Look up pension in Wiktionary, the free dictionary.
A pension is a fixed sum paid regularly to a person, typically, given following a retirement from service.[1] Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum.
The terms retirement plan or superannuation refer to a pension granted upon retirement.[2] Retirement plans may be set up by employers, insurance companies, the government or other institutions such as employer associations or trade unions. Called retirement plans in the United States, they are commonly known as pension schemes in the United Kingdom and Ireland and superannuation plans or super[3] in Australia and New Zealand. Retirement pensions are typically in the form of a guaranteed life annuity, thus insuring against the risk of longevity.
A pension created by an employer for the benefit of an employee is commonly referred to as an occupational or employer pension. Labor unions, the government, or other organizations may also fund pensions. Occupational pensions are a form of deferred compensation, usually advantageous to employee and employer for tax reasons. Many pensions also contain an additional insurance aspect, since they often will pay benefits to survivors or disabled beneficiaries. Other vehicles (certain lottery payouts, for example, or an annuity) may provide a similar stream of payments.
The common use of the term pension is to describe the payments a person receives upon retirement, usually under pre-determined legal and/or contractual terms. A recipient of a retirement pension is known as a pensioner or retiree.

Types of pensions

[edit]Employment-based pensions (retirement plans)
A retirement plan is an arrangement to provide people with an income during retirement when they are no longer earning a steady income from employment. Often retirement plans require both the employer and employee to contribute money to a fund during their employment in order to receive defined benefits upon retirement. It is a tax deferred savings vehicle that allows for the tax-free accumulation of a fund for later use as a retirement income. Funding can be provided in other ways, such as from labor unions, government agencies, or self-funded schemes. Pension plans are therefore a form of "deferred compensation". A SSAS is a type of employment-based Pension in the UK.
[edit]Social and state pensions
Many countries have created funds for their citizens and residents to provide income when they retire (or in some cases become disabled). Typically this requires payments throughout the citizen's working life in order to qualify for benefits later on. A basic state pension is a "contribution based" benefit, and depends on an individual's contribution history. For examples, see National Insurance in the UK, or Social Security in the USA. Many countries have also put in place a "social pension". These are regular, tax-funded non-contributory cash transfers paid to older people. Over 80 countries have social pensions.[4] Examples are the Old Age Grant in South Africa and the universal Superannuation scheme in New Zealand[4].
[edit]Disability pensions
Some pension plans will provide for members in the event they suffer a disability. This may take the form of early entry into a retirement plan for a disabled member below the normal retirement age.
[edit]Benefits

Retirement plans may be classified as defined benefit or defined contribution according to how the benefits are determined.[5] A defined benefit plan guarantees a certain payout at retirement, according to a fixed formula which usually depends on the member's salary and the number of years' membership in the plan. A defined contribution plan will provide a payout at retirement that is dependent upon the amount of money contributed and the performance of the investment vehicles utilized.
Some types of retirement plans, such as cash balance plans, combine features of both defined benefit and defined contribution plans. They are often referred to as hybrid plans. Such plan designs have become increasingly popular in the US since the 1990s. Examples include Cash Balance and Pension Equity plans.
[edit]Defined benefit plans
Main article: Defined benefit pension plan
A traditional defined benefit (DB) plan is a plan in which the benefit on retirement is determined by a set formula, rather than depending on investment returns. In the US, 26 U.S.C. § 414(j) specifies a defined benefit plan to be any pension plan that is not a defined contribution plan (see below) where a defined contribution plan is any plan with individual accounts. A traditional pension plan that defines a benefit for an employee upon that employee's retirement is a defined benefit plan.
Traditionally, retirement plans have been administered by institutions which exist specifically for that purpose, by large businesses, or, for government workers, by the government itself. A traditional form of defined benefit plan is the final salary plan, under which the pension paid is equal to the number of years worked, multiplied by the member's salary at retirement, multiplied by a factor known as the accrual rate. The final accrued amount is available as a monthly pension or a lump sum, but usually monthly.
The benefit in a defined benefit pension plan is determined by a formula that can incorporate the employee's pay, years of employment, age at retirement, and other factors. A simple example is a Dollars Times Service plan design that provides a certain amount per month based on the time an employee works for a company. For example, a plan offering $100 a month per year of service would provide $3,000 per month to a retiree with 30 years of service. While this type of plan is popular among unionized workers, Final Average Pay (FAP) remains the most common type of defined benefit plan offered in the United States. In FAP plans, the average salary over the final years of an employee's career determines the benefit amount.
Averaging salary over a number of years means that the calculation is averaging different dollars. For example, if salary is averaged over five years, and retirement is in 2009, then salary in 2004 dollars is averaged with salary in 2005 dollars, etc., with 2004 dollars being worth more than the dollars of succeeding years. The pension is then paid in first year of retirement dollars, in this example 2009 dollars, with the lowest value of any dollars in the calculation. Thus inflation in the salary averaging years has a considerable impact on purchasing power and cost, both being reduced equally by inflation
This effect of inflation can be eliminated by converting salaries in the averaging years to first year of retirement dollars, and then averaging.
In the United Kingdom, benefits are typically indexed for inflation (known as Retail Prices Index (RPI)) as required by law for registered pension plans.[6] Inflation during an employee's retirement affects the purchasing power of the pension; the higher the inflation rate, the lower the purchasing power of a fixed annual pension. This effect can be mitigated by providing annual increases to the pension at the rate of inflation (usually capped, for instance at 5% in any given year). This method is advantageous for the employee since it stabilizes the purchasing power of pensions to some extent.
If the pension plan allows for early retirement, payments are often reduced to recognize that the retirees will receive the payouts for longer periods of time. In the United States, under the Employee Retirement Income Security Act of 1974, any reduction factor less than or equal to the actuarial early retirement reduction factor is acceptable.[7]
Many DB plans include early retirement provisions to encourage employees to retire early, before the attainment of normal retirement age (usually age 65). Companies would rather hire younger employees at lower wages. Some of those provisions come in the form of additional temporary or supplemental benefits, which are payable to a certain age, usually before attaining normal retirement age.[8]
[edit]Funding
Defined benefit plans may be either funded or unfunded.
In an unfunded defined benefit pension, no assets are set aside and the benefits are paid for by the employer or other pension sponsor as and when they are paid. Pension arrangements provided by the state in most countries in the world are unfunded, with benefits paid directly from current workers' contributions and taxes. This method of financing is known as Pay-as-you-go (PAYGO or PAYG).[9] The social security systems of many European countries are unfunded[citation needed], having benefits paid directly out of current taxes and social security contributions, although several countries have hybrid systems which are partially funded. Spain set up the Social Security Reserve Fund and France set up the Pensions Reserve Fund; in Canada the wage-based retirement plan (CPP) is funded, with assets managed by the CPP Investment Board while the U.S. Social Security system is funded by investment in special U.S. Treasury Bonds.
In a funded plan, contributions from the employer, and sometimes also from plan members, are invested in a fund towards meeting the benefits. The future returns on the investments, and the future benefits to be paid, are not known in advance, so there is no guarantee that a given level of contributions will be enough to meet the benefits. Typically, the contributions to be paid are regularly reviewed in a valuation of the plan's assets and liabilities, carried out by an actuary to ensure that the pension fund will meet future payment obligations. This means that in a defined benefit pension, investment risk and investment rewards are typically assumed by the sponsor/employer and not by the individual. If a plan is not well-funded, the plan sponsor may not have the financial resources to continue funding the plan. In many countries, such as the USA, the UK and Australia, most private defined benefit plans are funded[citation needed], because governments there provide tax incentives to funded plans (in Australia they are mandatory). In the United States, non-church-based private employers must pay an insurance-type premium to the Pension Benefit Guaranty Corporation, a government agency whose role is to encourage the continuation and maintenance of voluntary private pension plans and provide timely and uninterrupted payment of pension benefits.

Traditional defined benefit plan designs (because of their typically flat accrual rate and the decreasing time for interest discounting as people get closer to retirement age) tend to exhibit a J-shaped accrual pattern of benefits, where the present value of benefits grows quite slowly early in an employee's career and accelerates significantly in mid-career: in other words it costs more to fund the pension for older employees than for younger ones (an "age bias"). Defined benefit pensions tend to be less portable than defined contribution plans, even if the plan allows a lump sum cash benefit at termination. Most plans, however, pay their benefits as an annuity, so retirees do not bear the risk of low investment returns on contributions or of outliving their retirement income. The open-ended nature of these risks to the employer is the reason given by many employers for switching from defined benefit to defined contribution plans over recent years. The risks to the employer can sometimes be mitigated by discretionary elements in the benefit structure, for instance in the rate of increase granted on accrued pensions, both before and after retirement.
The age bias, reduced portability and open ended risk make defined benefit plans better suited to large employers with less mobile workforces, such as the public sector (which has open-ended support from taxpayers). This coupled with a lack of foresight on the employers part means a large proportion of the workforce are kept in the dark over future investment schemes.
Defined benefit plans are sometimes criticized as being paternalistic as they enable employers or plan trustees to make decisions about the type of benefits and family structures and lifestyles of their employees. However they are typically more valuable than defined contribution plans in most circumstances and for most employees (mainly because the employer tends to pay higher contributions than under defined contribution plans), so such criticism is rarely harsh.
The "cost" of a defined benefit plan is not easily calculated, and requires an actuary or actuarial software. However, even with the best of tools, the cost of a defined benefit plan will always be an estimate based on economic and financial assumptions. These assumptions include the average retirement age and lifespan of the employees, the returns to be earned by the pension plan's investments and any additional taxes or levies, such as those required by the Pension Benefit Guaranty Corporation in the U.S. So, for this arrangement, the benefit is relatively secure but the contribution is uncertain even when estimated by a professional.
[edit]Examples
Many countries offer state-sponsored retirement benefits, beyond those provided by employers, which are funded by payroll or other taxes. The United States Social Security system is similar to a defined benefit pension arrangement, albeit one that is constructed differently than a pension offered by a private employer.
Individuals that have worked in the UK and have paid certain levels of national insurance deductions can expect an income from the state pension scheme after their normal retirement. The state pension is currently divided into two parts: the basic state pension, State Second [tier] Pension scheme called S2P. Individuals will qualify for the basic state pension if they have completed sufficient years contribution to their national insurance record. The S2P pension scheme is earnings related and depends on earnings in each year as to how much an individual can expect to receive. It is possible for an individual to forgo the S2P payment from the state, in lieu of a payment made to an appropriate pension scheme of their choice, during their working life. For more details see UK pension provision.
[edit]Defined contribution plans
Main article: Defined contribution plan
In a defined contribution plan, contributions are paid into an individual account for each member. The contributions are invested, for example in the stock market, and the returns on the investment (which may be positive or negative) are credited to the individual's account. On retirement, the member's account is used to provide retirement benefits, sometimes through the purchase of an annuity which then provides a regular income. Defined contribution plans have become widespread all over the world in recent years, and are now the dominant form of plan in the private sector in many countries. For example, the number of defined benefit plans in the US has been steadily declining, as more and more employers see pension contributions as a large expense avoidable by disbanding the defined benefit plan and instead offering a defined contribution plan.
Money contributed can either be from employee salary deferral or from employer contributions. The portability of defined contribution pensions is legally no different from the portability of defined benefit plans. However, because of the cost of administration and ease of determining the plan sponsor's liability for defined contribution plans (you do not need to pay an actuary to calculate the lump sum equivalent that you do for defined benefit plans) in practice, defined contribution plans have become generally portable.
In a defined contribution plan, investment risk and investment rewards are assumed by each individual/employee/retiree and not by the sponsor/employer, and these risks may be substantial.[10] In addition, participants do not necessarily purchase annuities with their savings upon retirement, and bear the risk of outliving their assets. (In the United Kingdom, for instance, it is a legal requirement to use the bulk of the fund to purchase an annuity.)
The "cost" of a defined contribution plan is readily calculated, but the benefit from a defined contribution plan depends upon the account balance at the time an employee is looking to use the assets. So, for this arrangement, the contribution is known but the benefit is unknown (until calculated).
Despite the fact that the participant in a defined contribution plan typically has control over investment decisions, the plan sponsor retains a significant degree of fiduciary responsibility over investment of plan assets, including the selection of investment options and administrative providers.
[edit]Examples
In the United States, the legal definition of a defined contribution plan is a plan providing for an individual account for each participant, and for benefits based solely on the amount contributed to the account, plus or minus income, gains, expenses and losses allocated to the account (see 26 U.S.C. § 414(i)). Examples of defined contribution plans in the United States include Individual Retirement Accounts (IRAs) and 401(k) plans. In such plans, the employee is responsible, to one degree or another, for selecting the types of investments toward which the funds in the retirement plan are allocated. This may range from choosing one of a small number of pre-determined mutual funds to selecting individual stocks or other securities. Most self-directed retirement plans are characterized by certain tax advantages, and some provide for a portion of the employee's contributions to be matched by the employer. In exchange, the funds in such plans may not be withdrawn by the investor prior to reaching a certain age—typically the year the employee reaches 59.5 years old-- (with a small number of exceptions) without incurring a substantial penalty.
In the US, defined contribution plans are subject to IRS limits on how much can be contributed, known as the section 415 limit. In 2009, the total deferral amount, including employee contribution plus employer contribution, was limited to $49,000 or 100% of compensation, whichever is less. The employee-only limit in 2009 is $16,500 with a $5,500 catch-up. These numbers may increase each year and are indexed to compensate for the effects of inflation.
Examples of defined contribution pension schemes in other countries are, the UK’s personal pensions and proposed National Employment Savings Trust (NEST), Germany’s Riester plans, Australia’s Superannuation system and New Zealand’s KiwiSaver scheme. Individual pension savings plans also exist in Austria, Czech Republic, Denmark, Greece, Finland, Ireland, Netherlands, Slovenia and Spain[11]
[edit]Hybrid and cash balance plans
Hybrid plan designs combine the features of defined benefit and defined contribution plan designs.
A cash balance plan is a defined benefit plan made by the employer, with the help of consulting actuaries (like Kwasha Lipton, who it is said created the cash balance plan) to appear as if they were defined contribution plans. They have notional balances in hypothetical accounts where, typically, each year the plan administrator will contribute an amount equal to a certain percentage of each participant's salary; a second contribution, called interest credit, is made as well. These are not actual contributions and further discussion is beyond the scope of this entry suffice it to say that there is currently much controversy. In general, they are usually treated as defined benefit plans for tax, accounting and regulatory purposes. As with defined benefit plans, investment risk in hybrid designs is largely borne by the plan sponsor. As with defined contribution designs, plan benefits are expressed in the terms of a notional account balance, and are usually paid as cash balances upon termination of employment. These features make them more portable than traditional defined benefit plans and perhaps more attractive to a more highly mobile workforce.
Target benefit plans are defined contribution plans made to match (or resemble) defined benefit plans.
[edit]Contrasting types of retirement plans
Advocates of defined contribution plans point out that each employee has the ability to tailor the investment portfolio to his or her individual needs and financial situation, including the choice of how much to contribute, if anything at all. However, others state that these apparent advantages could also hinder some workers who might not possess the financial savvy to choose the correct investment vehicles or have the discipline to voluntarily contribute money to retirement accounts. This debate parallels the discussion currently going on in the U.S., where many Republican leaders favor transforming the Social Security system, at least in part, to a self-directed investment plan.

Financing

There are various ways in which a pension may be financed.
This section requires expansion.
Defined contribution pensions, by definition, are funded, as the "guarantee" made to employees is that specified (defined) contributions will be made during an individual's working life.
There are many ways to finance your pension and save for retirement. Pension plans can be set up by your employer, matching your contribution each month, by the state or personally through a pension scheme with a financial institution, such as a bank or brokerage firm. Pension plans often come with a tax break depending on the country and plan type.
For example Canadian’s have the option to open a Registered Retirement Savings Plan (RRSP), as well as a range of employee and state pension programs[12]. This plan allows contributions to this account to be marked as un-taxable income and remain un-taxed until withdrawal. Most country’s governments will provide advice on pension schemes.
[edit]History

This section requires expansion.
Widows' funds were among the first pension type arrangement to appear, for example Duke Ernest the Pious of Gotha in Germany, founded a widows' fund for clergy in 1645 and another for teachers in 1662.[13] 'Various schemes of provision for ministers' widows were then established throughout Europe at about the start of the eighteenth century, some based on a single premium others based on yearly premiums to be distributed as benefits in the same year.'[14]
[edit]Germany
As part of Otto von Bismarck's social legislation, the Old Age and Disability Insurance Bill was enacted in 1889. The Old Age Pension program, financed by a tax on workers, was originally designed to provide a pension annuity for workers who reached the age of 70 years, though this was lowered to 65 years in 1916. It is sometimes claimed that at the time life expectancy for the average Prussian was 45 years; in fact this figure ignores the very high infant mortality and high maternal death rate from childbirth of this era. In fact, an adult entering into insurance under the scheme would on average live to 70 years of age, a figure used in the actuarial assumptions included in the legislation.
[edit]Ireland
There is a history of pensions in Ireland that can be traced back to Brehon Law imposing a legal responsibility on the kin group to take care of its members who were aged, blind, deaf, sick or insane.[15] For a discussion on pension funds and early Irish law, see F Kelly, A Guide to Early Irish Law (Dublin, Dublin Institute for Advanced Studies, 1988). In 2010, over 76,291 pension schemes operating in Ireland.[16]
Ireland has a two-tiered approach to the provision of pensions or retirement benefits. First, there is a State social welfare retirement pension, which promises a basic level of pension. This is a flat rate pension, funded by the State social insurance system and is termed Pay Related Social Insurance or PRSI. Secondly, there are the occupational pension schemes and self-employed arrangements, which supplement the State pension.

[edit]United States
Public pensions got their start with various 'promises', informal and legislated, made to veterans of the Revolutionary War and, more extensively, the Civil War. They were expanded greatly, and began to be offered by a number of state and local governments during the early Progressive Era in the late nineteenth century.[citation needed]
Federal civilian pensions were offered under the Civil Service Retirement System (CSRS), formed in 1920. CSRS provided retirement, disability and survivor benefits for most civilian employees in the US Federal government, until the creation of a new Federal agency, the Federal Employees Retirement System (FERS), in 1987.
Pension plans became popular in the United States during World War II, when wage freezes prohibited outright increases in workers' pay. The defined benefit plan had been the most popular and common type of retirement plan in the United States through the 1980s; since that time, defined contribution plans have become the more common type of retirement plan in the United States and many other western countries.
In April 2012, the Northern Mariana Islands Retirement Fund filed for Chapter 11 bankruptcy protection. The retirement fund is a defined benefit type pension plan and was only partially funded by the government, with only $268.4 million in assets and $911 million in liabilities. The plan experienced low investment returns and a benefit structure that had been increased without raises in funding. [17] According to Pensions and Investments, this is "apparently the first" US public pension plan to declare bankruptcy.[17]
[edit]Current challenges

A growing challenge for many nations is population ageing. As birth rates drop and life expectancy increases an ever-larger portion of the population is elderly. This leaves fewer workers for each retired person. In almost all developed countries this means that government and public sector pensions could collapse their economies unless pension systems are reformed or taxes are increased. One method of reforming the pension system is to increase the retirement age. Two exceptions are Australia and Canada, where the pension system is forecast to be solvent for the foreseeable future.[citation needed] In Canada, for instance, the annual payments were increased by some 70% in 1998 to achieve this. These two nations also have an advantage from their relative openness to immigration. However, their populations are not growing as fast as the U.S., which supplements a high immigration rate with one of the highest birthrates among Western countries. Thus, the population in the U.S. is not aging to the extent as those in Europe, Australia, or Canada.
Another growing challenge is the recent trend of states and businesses in the United States purposely under-funding their pension schemes in order to push the costs onto the federal government. For example, in 2009, the majority of states have unfunded pension liabilities exceeding all reported state debt. Bradley Belt, former executive director of the PBGC (the Pension Benefit Guaranty Corporation, the federal agency that insures private-sector defined-benefit pension plans in the event of bankrupment), testified before a congressional hearing in October 2004, “I am particularly concerned with the temptation, and indeed, growing tendency, to use the pension insurance fund as a means to obtain an interest-free and risk-free loan to enable companies to restructure. Unfortunately, the current calculation appears to be that shifting pension liabilities onto other premium payers or potentially taxpayers is the path of least resistance rather than a last resort.”
Challenges have further been increased by the credit crunch. Total funding of the nation's 100 largest corporate pension plans fell by $303bn in 2008, going from a $86bn surplus at the end of 2007 to a $217bn deficit at the end of 2008.[18]
[edit]Pensions by country

General articles on both public and private pension funds by country:
Pensions in Canada
Pensions in Chile
Pensions in India
Pensions in Norway
Pensions in Pakistan
Pensions in the United States
Pensions in the United Kingdom
[edit]Famous examples of pension systems

Some of the listed systems might also be considered social insurance.
Argentina:
Administración Nacional de la Seguridad Social
Australia:
Superannuation in Australia - Private occupational pensions
Social Security - Public pensions
Canada:
Canada Pension Plan
Old Age Security
Quebec Pension Plan
Registered Retirement Savings Plan
Saskatchewan Pension Plan
Hong Kong - Mandatory Provident Fund
Finland - Kansaneläkelaitos
India - Employees' Provident Fund Organisation of India
Japan - National Pension
Malaysia - Employees Provident Fund
Mexico - Mexico Pension Plan
Netherlands - Algemene Ouderdoms Wet
New Zealand - KiwiSaver
Singapore - Central Provident Fund
Sweden - Social Security
United Kingdom:
UK pension provision (generally)
Self-invested personal pensions
United States:
Public employee pensions
Retirement plans in the United States
Social Security
[edit]Market structure

The market for pension fund investments is still centered around the U.K.and U.S. economies.[citation needed] Japan and the EU are conspicuous by absence.[citation needed] As of 2005 the U.S. was the largest market for pension fund investments followed by the UK.[citation needed]
Pension reforms have gained pace worldwide in recent years and funded arrangements are likely to play an increasingly important role in delivering retirement income security and also affect securities markets in future years.
[edit]Obtaining survey data on pensions

Numerous worldwide health, aging and retirement surveys contain questions pertaining to pensions. The Meta Data Repository - created by the non-profit RAND Corporation and sponsored by the National Institute on Aging at the National Institutes of Health - provides access to meta data for these questions as well as links to obtain respondent data from the originating surveys.
[edit]See also

Elderly care
Financial advisor and Fee-only financial advisor
Generational accounting
Pensions crisis
Pension system
Public debt
Retirement age
Specific:
Roth 401(k)
Bankruptcy code
Individual Pension Plan (IPP)
Universities Superannuation Scheme
Provident Fund
Ham and Eggs Movement, California pension proposal of the 1930s-40s

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Types of retirement plans

Retirement plans are classified as defined benefit or defined contribution according to how benefits are determined. A defined benefit (or pension) plan calculates benefits using a fixed formula that typically factors in final pay and service with an employer, and payments are made from a trust fund specifically dedicated to the plan. In a defined contribution plan, the payout is dependent upon both the amount of money contributed into an individual account and the performance of the investment vehicles utilized.

Some types of retirement plans, such as cash balance plans, combine features of both defined benefit and defined contribution schemes.

[edit] Defined contribution plan

According to the Internal Revenue Code Section 414, a defined contribution plan is an employer-sponsored plan with an individual account for each participant. The accrued benefit from such a plan is solely attributable to contributions made into an individual account and investment gains on those funds, less any losses and expense charges. The contributions are invested (e.g., in the stock market), and the returns on the investment are credited to or deducted from the individual's account. Upon retirement, the participant's account is used to provide retirement benefits, often through the purchase of an annuity. Defined contribution plan have become more widespread over recent years and are now the dominant form of plan in the private sector. The number of defined benefit plans in the US has been steadily declining, as more employers see pension funding as a financial risk they can avoid by freezing the plan and instead offering a defined contribution plan.

Examples of Defined contribution plan include Individual Retirement Account (IRA), 401(k), and profit sharing plans. In such plans, the participant is responsible for selecting the types of investments toward which the funds in the retirement plan are allocated. This may range from choosing one of a small number of pre-determined mutual funds to selecting individual stocks or other securities. Most self-directed retirement plans are characterized by certain tax advantages. The funds in such plans may not be withdrawn without penalty until the investor reaches retirement age, which is typically 59.5 years of age.

Money contributed can be from employee salary deferrals, employer contributions, or employer matching contributions. Defined contribution plan are subject to IRS section 415 limits on how much can be contributed. As of 2012, the total deferral amount including the employee and employer contribution is the lesser of $50,000 or 100% of compensation. The employee-only amount is $17,000 for 2012, but a plan can permit participants who are age 50 or older to make "catch-up" contributions of up to an additional $5,500.

[edit] Defined benefit plans

Commonly referred to as a pension in the US, a defined benefit plan pays benefits from a trust fund using a specific formula set forth by the plan sponsor. In other words, the plan defines a benefit that will be paid upon retirement. The statutory definition of defined benefit encompasses all pension plans that are not defined contribution and therefore do not have individual accounts.

While this catch-all definition has been interpreted by the courts to capture some hybrid pension plans like cash balance (CB) plans and pension equity plans (PEP), most pension plans offered by large businesses or government agencies are final average pay (FAP) plans, under which the monthly benefit is equal to the number of years worked multiplied by the member's salary at retirement multiplied by a factor known as the accrual rate. At a minimum, benefits are payable in normal form as a Single Life Annuity (SLA) for single participants or as a Qualified Joint and Survivor Annuity (QJSA) for married participants. Both normal forms are paid at Normal Retirement Age (usually 65) and may be actuarially adjusted for early or late commencement. Other optional forms of payment, such as lump sum distributions, may be available but are not required.

The cash balance plan typically offers a lump sum at and often before normal retirement age. However, as is the case with all defined benefit plans, a cash balance plan must also provide the option of receiving the benefit as a life annuity. The amount of the annuity benefit must be definitely determinable as per IRS regulation 1.412-1.

Defined benefit plans may be either funded or unfunded. In a funded plan, contributions from the employer and participants are invested into a trust fund dedicated solely to paying benefits to retirees under a given plan. The future returns on the investments and the future benefits to be paid are not known in advance, so there is no guarantee that a given level of contributions will meet future obligations. Therefore, fund assets and liabilities are regularly reviewed by an actuary in a process known as valuation. A defined benefit plan is required to maintain adequate funding if it is to remain qualified.

In an unfunded plan, no funds are set aside for the specific purpose of paying benefits. The benefits to be paid are met immediately by contributions to the plan or by general assets. Most government-run retirement plans, including Social Security, are unfunded, with benefits being paid directly out of current taxes and Social Security contributions. Most nonqualified plans are also unfunded.

[edit] Hybrid and Cash Balance Plans

Hybrid plan designs combine the features of defined benefit and defined contribution plan designs. In general, they are treated as defined benefit plans for tax, accounting, and regulatory purposes. As with defined benefit plans, investment risk is largely borne by the plan sponsor. As with defined contribution designs, plan benefits are expressed in the terms of a notional account balance, and are usually paid as cash balances upon termination of employment. These features make them more portable than traditional defined benefit plans and perhaps more attractive to a highly mobile workforce. A typical hybrid design is the Cash Balance Plan, where the employee's notional account balance grows by some defined rate of interest and annual employer contribution.

In the US, conversions from traditional to hybrid plan designs have been controversial. Upon conversion, plan sponsors are required to retrospectively calculate employee account balances, and if the employee's actual vested benefit under the old design is more than the account balance, the employee enters a period of wear away. During this period, the employee would be eligible to receive the already accrued benefit under the old formula, but all future benefits are accrued under the new plan design. Eventually, the accrued benefit under the new design exceeds the grandfathered amount under the old design. To the participant, however, it appears as if there is a period where no new benefits are accrued. Hybrid designs also typically eliminate the more generous early retirement provisions of traditional pensions.

Since younger workers have more years in which to accrue interest and pay credits than those approaching retirement age, critics of cash balance plans have called the new designs discriminatory. On the other hand, the new designs may better meet the needs of a modern workforce and actually encourage older workers to remain at work, since benefit accruals continue at a constant pace as long as an employee remains on the job. As of 2008, the courts have generally rejected the notion that cash balance plans discriminate based on age, while the Pension Protection Act of 2006 offers relief for most hybrid plans on a prospective basis.

While a cash balance plan is technically a defined benefit plan designed to allow workers to evaluate the economic worth their pension benefit in the manner of a defined contribution plan (i.e., as an account balance), the target benefit plan is a defined contribution plan designed to express its projected impact in terms of lifetime income as a percent of final salary at retirement (i.e., as an annuity amount). For example, a target benefit plan may mimic a typical defined benefit plan offering 1.5% of salary per year of service times the final 3-year average salary. Actuarial assumptions like 5% interest, 3% salary increases and the UP84 Life Table for mortality are used to calculate a level contribution rate that would create the needed lump sum at retirement age. The problem with such plans is that the flat rate could be low for young entrants and high for old entrants. While this may appear unfair, the skewing of benefits to the old worker is a feature of most traditional defined benefit plans, and any attempt to match it would reveal this backloading feature.

[edit] Requirement of Permanence

To guard against tax abuse in the United States, the Internal Revenue Service (IRS) has promulgated rules that require that pension plans be permanent as opposed to a temporary arrangement used to capture tax benefits. Regulation 1.401-1(b)(2) states that "[t]hus, although the employer may reserve the right to change or terminate the plan, and to discontinue contributions thereunder, the abandonment of the plan for any reason other than business necessity within a few years after it has taken effect will be evidence that the plan from its inception was not a bona fide program for the exclusive benefit of employees in general. Especially will this be true if, for example, a pension plan is abandoned soon after pensions have been fully funded for persons in favor of whom discrimination is prohibited..." The IRS would have grounds to disqualify the plan retroactively, even if the plan sponsor initially got a favorable determination letter.

[edit] Qualified retirement plans

Qualified plans receive favorable tax treatment and are regulated by ERISA. The technical definition of qualified does not agree with the commonly used distinction. For example, 403(b) plans are not considered qualified plans, but are treated and taxed almost identically.

The term qualified has special meaning regarding defined benefit plans. The IRS defines strict requirements a plan must meet in order to receive favorable tax treatment, including:

A plan must offer life annuities in the form of a Single Life Annuity (SLA) and a Qualified Joint & Survivor Annuity (QJSA).
A plan must maintain sufficient funding levels.
A plan must be administered according to the plan document.
Benefits are required to commence at retirement age (usually age 65 if no longer working, or age 70 1/2 if still employed).
Once earned, benefits may not be forfeited.
A plan may not discriminate in favor of highly-compensated employees.
A plan must be insured by the PBGC.
Failure to meet IRS requirements can lead to plan disqualification, which carries with it enormous tax consequences.

[edit] SIMPLE IRAs

A SIMPLE IRA is a type of Individual Retirement Account (IRA) that is provided by an employer. It is similar to a 401(k) but offers simpler and less costly administration rules. Like a 401(k) plan, the SIMPLE IRA is funded by a pre-tax salary reduction. However, contribution limits for SIMPLE plans are lower than for most other types of employer-provided retirement plans.

[edit] SEP IRAs

A Simplified Employee Pension Individual Retirement Account, or SEP IRA, is a variation of the Individual Retirement Account. SEP IRAs are adopted by business owners to provide retirement benefits for the business owners and their employees. There are no significant administration costs for self-employed person with no employees. If the self-employed person does have employees, all employees must receive the same benefits under a SEP plan. Since SEP accounts are treated as IRAs, funds can be invested the same way as any other IRA.

[edit] Keogh or HR10 Plans

Keogh plans are full-fledged pension plans for the self-employed. Named for U.S. Representative Eugene James Keogh of New York, they are sometimes called HR10 plans.

[edit] Nonqualified plans

Plans that do not meet the guidelines required to receive favorable tax treatment are considered nonqualified and are exempt from the restrictions placed on qualified plans. They are typically used to provide additional benefits to key or highly-paid employees, such as executives and officers. Examples include SERP (Supplemental Executive Retirement Plans) and 457(f) plans.

[edit] Contrasting types of retirement plans

Advocates of Defined contribution plan point out that each employee has the ability to tailor the investment portfolio to his or her individual needs and financial situation, including the choice of how much to contribute, if anything at all. However, others state that these apparent advantages could also hinder some workers who might not possess the financial savvy to choose the correct investment vehicles or have the discipline to voluntarily contribute money to retirement accounts.

[edit] Portability, Valuation

Defined contribution plan have actual balances, that workers can simply know the value of with certainty by simply checking the balance. There is no legal requirement that the employer allow the former worker take his money out to roll over into an IRA, though it is relatively uncommon in the US not to allow this (and many companies such as Fidelity run numerous TV ads encouraging individuals to transfer their old plans into current ones).

However, because the lump sum actuarial present value of a former worker's vested accrued benefit is uncertain, the IRS (in Section 417(e) of the Internal Revenue) Code specifies the interest and mortality that must be used. This has caused some employers as in the Berger versus Xerox case in the 7th Circuit (Richard A. Posner was the judge who wrote the opinion) with cash balance plans to have a higher liability for employers for a lump sum than was in the employee's "notional" or "hypothetical" account balance.

When the interest credit rate exceeds the IRS mandated Section 417(e) discounting rate, the legally mandated lump sum value payable to the employee [if the plan sponsor allows for pre-retirement lump sums] would exceed the notional balance in the employee's cash balance account. This has been colourfully dubbed the "Whipsaw" in actuarial parlance. The Pension Protection Act signed into law on August 17, 2006 contained added provisions for these types of plans allowing the distribution of the cash balance account as a lump sum.

[edit] Portability: Practical, not a Legal difference

A practical difference is that a defined contribution plan's assets generally remain with the employee (generally, amounts contributed by the employee and earnings on them remain with the employee, but employer contributions and earnings on them do not vest with the employee until a specified period has elapsed), even if he or she transfers to a new job or decides to retire early, whereas in many countries defined benefit pension benefits are typically lost if the worker fails to serve the requisite number of years with the same company. Self-directed accounts from one employer may usually be 'rolled-over' to another employer's account or converted from one type of account to another in these cases.

Because Defined contribution plan have actual balances, employers can simply write a check because the amount of their liability at termination of employment which may be decades before actual normal (65) retirement date of the plan, is known with certainty. There is no legal requirement that the employer allow the former worker take his money out to roll over into an IRA, though it is relatively uncommon in the US not to allow this.

Just like there is no legal requirement to give portability to Defined contribution plan, there is no mandated ban on portability for defined benefit plans. However, because the lump sum actuarial present value of a former worker's vested accrued benefit is uncertain, the IRS mandate in Section 417(e) of the Internal Revenue Code specifies the interest and mortality that must be used. This uncertainty discussed in valuaton of defined benefit lump sums has limited the practical portality of defined benefit plans.

[edit] Investment Risk borne by Employee or Employer

It is commonly said that the employee bears investment risk for Defined contribution plan while the employer bears that risk in defined benefit plans. This is true for practically all cases, but pension law in the United States does not require that employees bear investment risk, it only provides an ERISA Section 404(c) exemption from fiduciary liability if the employer provides the mandated investment choices and gives employees sufficient control to customize his pension investment portfolio APPROPRIATE to his risk tolerance.

[edit] PBGC insurance: a legal difference

The Employee Retirement Income Security Act (ERISA) does not provide insurance from the Pension Benefit Guaranty Corporation (PBGC) for Defined contribution plan, but cash balance plans do get such insurance because they, like all ERISA-defined benefit plans, are covered by the PBGC.

Plans may also be either employer-provided or individual plans. Most types of retirement plans are employer-provided, though Individual Retirement Accounts (IRAs) are very common.

[edit] Tax advantages

Most retirement (the exception being most non qualified plans) plans offer significant tax advantages. Most commonly the money contributed to the account is not taxed as income to the employee, but in the case of employer provided plans, the employer is able to receive a tax deduction for the amount contributed as if it were regular employee compensation. This is known as pre-tax contributions, and the amounts allowed to be contributed vary significantly among various plan types. The other significant advantage is that the money in the plan is allowed to grow through investing without being taxed on the growth each year. Once the money is withdrawn it is taxed fully as income. There are many restrictions on contributions, especially with 401(k) and defined benefit plans that are designed to make sure that highly compensated employees do not gain too much tax advantage at the expense of lesser paid employees.

Currently two types of plan, the Roth IRA and the newly introduced Roth 401(k), offer tax advantages that are essentially reversed from most retirement plans. Contributions to Roth IRAs and Roth 401(k)s must be made with money that has been taxed as income, but after meeting the various restrictions, money withdrawn from the account is tax-free.

[edit] EGTRRA and later changes

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) brought significant changes to retirement plans, generally easing restrictions on the ability to roll money from one type of account to the other and increasing contributions limits. Most of the changes were designed to phase in over a period of 4–10 years. Unless they are extended, it will "sunset," or revert, at the end of 2010 to the previous laws.

[edit] History of pensions in the United States

1717: The Presbyterian Church creates a Fund for Pious Uses to provide for retired ministers.[1]
1875: The American Express Company creates the first pension plan in the United States.[2]
1884: Baltimore and Ohio Railroad establishes the first pension plan by a major employer, allowing workers at age 65 who had worked for the railroad for at least 10 years to retire and receive benefits ranging from 20 to 35% of wages.[3]
The Revenue Act of 1913, passed following the passage of the 16th amendment to the constitution which permitted income taxation, recognized the tax exempt nature of pension trusts. At the time, several large pension trusts were already in existence- including the pension trust for ministers of the Anglican Church in the United States.
1924: The Presbyterian Church, USA, creates its current pension program[1]
1940s: General Motors chairman Charles Erwin Wilson designed GM's first modern pension fund. He said that it should invest in all stocks, not just GM.
1963: Studebaker terminated its underfunded pension plan, leaving employees with no legal recourse for their pension promises.
1974: Employee Retirement Income Security Act (ERISA) – imposed reporting and disclosure obligations and minimum standards for participation, vesting, accrual and funding on U.S. plan sponsors, established fiduciary standards applicable to plan administrators and asset managers, established the Pension Benefit Guaranty Corporation to ensure benefits for participants in terminated defined benefit plans, updated the Internal revenue Code rules for tax qualification, and authorized Employee Stock Ownership Plans ("ESOPs") and Individual Retirement Accounts ("IRAs"). Championed by Senators Jacob K. Javits, Harrison A. Williams, Russell Long, and Gaylord Nelson, and by Representatives John Dent and John Erlenborn.
1985: The First Cash Balance Plan - Kwasha Lipton creates it by amending the plan document of Bank of America pension plan. The linguistic move was to avoid mentioning actual individual accounts but using the words hypothetical account or notional account.
1991: A Magazine article claims that pension- and retirement funds own 40% of American common stock and represent $2.5 trillion in assets.[4]
Growth and Decline of Defined Benefit Pension Plans in the United States. In 1980 there were approximately 250,000 qualified defined benefit pension plans covered by the Pension Benefit Guaranty Corporation. By 2005, there are less than 80,000 qualified plans.
[edit] See also

Retirement plan
Individual Retirement Account (IRA)
Public Employee Pension Plans
401(k)
403(b) - Similar to the 401(k), but for educational, religious, public healthcare, or non-profit workers
401(a) and 457 plans - For employees of state and local governments and certain tax-exempt entities
Roth IRA - Similar to the IRA, but funded with after-tax dollars, with distributions being tax-free
Roth 401(k) - Introduced in 2006; a 401(k) plan with the tax features of a Roth IRA

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What is the method of calculating monthly pension as per EPFO pension fund scheme?

What is the method of calculating monthly pension as per EPFO pension fund scheme?

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