The question, "What is the retirement thing called?" can have several answers, as it refers to a wide range of financial plans and arrangements. The most common names include pension plans, 401(k) plans, and Individual Retirement Arrangements (IRAs). While all serve the purpose of saving for retirement, they differ significantly in structure, management, and risk.
Defined benefit vs. defined contribution plans
When seeking to understand what retirement plans are called, it's crucial to grasp the two main categories they fall into: defined benefit plans and defined contribution plans. This foundational distinction clarifies who bears the investment risk and how your retirement income is determined.
Defined benefit plans: The traditional pension
A defined benefit (DB) plan is what most people traditionally think of as a pension. It is an employer-sponsored plan that promises a specific monthly benefit at retirement, typically based on a formula involving your salary history and years of service. Employers bear the investment risk and are responsible for ensuring the fund has enough money to pay out promised benefits, providing retirees with predictable, monthly payments for life. These plans are less common in the private sector now due to costs, but are still prevalent for government employees.
Defined contribution plans: The modern 401(k)
In a defined contribution (DC) plan, the amount of money contributed is defined, but the retirement benefit is not. Your retirement income depends on how much you and your employer contribute and how your investments perform. Employees typically control investment choices and take on the investment risk. Total savings depend on contributions and investment gains, offering potential for higher returns with higher risk.
A comparison of popular retirement vehicles
Here is a table comparing some of the most common types of retirement plans to help you better understand their features and who they are best for:
| Feature | Pension (Defined Benefit Plan) | 401(k) (Defined Contribution Plan) | IRA (Individual Retirement Account) |
|---|---|---|---|
| Sponsor | Employer | Employer | Individual |
| Contribution Source | Primarily employer | Employee and optional employer match | Individual |
| Guaranteed Income | Yes, fixed monthly payments | No, depends on investments | No, depends on investments |
| Investment Risk | Borne by the employer | Borne by the employee | Borne by the individual |
| Who It's Best For | Employees of companies still offering traditional pensions, often government workers | Employees of private companies who want more control over their investments | Individuals, self-employed, or those who want additional retirement savings |
| Common Forms | Traditional pension, government pension | Traditional 401(k), Roth 401(k) | Traditional IRA, Roth IRA, SEP IRA |
Other noteworthy retirement vehicles
Beyond the primary options, several other financial instruments contribute to a person's retirement income and are often referred to as parts of "the retirement thing."
- Social Security benefits: A federal insurance program providing monthly payments to qualified retired workers and their families, based on their highest 35 years of earnings.
- Annuities: Contracts with insurance companies providing future regular payments in exchange for a lump sum or series of payments. They can supplement other retirement income.
- Hybrid plans: These plans, like cash balance plans, combine aspects of defined benefit and defined contribution plans. They credit an account with a percentage of salary plus interest, but the employer holds the investment risk.
Planning your retirement: A combination of vehicles
For most people, a financially secure retirement involves using a combination of these "things" to build a robust nest egg. This might include an employer 401(k), a self-managed IRA, and Social Security benefits as a foundation.
Starting early and contributing consistently is key, allowing investments more time to grow through compounding interest. Regular contributions and smart investment decisions are essential for a comfortable post-work life.
Retirement preparation also involves lifestyle and healthcare cost considerations. Whether planning full retirement, downsizing, or phased retirement, a clear financial plan provides peace of mind.
Conclusion
While there is no single answer to "What is the retirement thing called?", the term typically refers to financial vehicles like pensions, 401(k)s, and IRAs used to fund life after work. Understanding the distinction between defined benefit and defined contribution plans is crucial. Most successful retirees use a combination of these plans, along with Social Security, for a diversified financial future. Starting early, contributing consistently, and knowing your options are vital steps towards a comfortable retirement.
