Pension Plan

A pension plan is an agreement between an employer and its employees to pay retirement benefits. A defined benefit pension plan states the benefits that management must pay, according to a predetermined formula. A defined contribution pension plan states the required contributions management must make, not the benefits it must pay; outlays to beneficiaries depend on the investment return on funds invested in the pension plan. Employees may also be required or allowed to contribute to a firm's pension plan. A pension plan usually contains tax benefits for both the employer and beneficiary: the investment income of a pension fund is ordinarily tax-exempt, and benefits paid to retirees are taxed when paid, not earned. Nevertheless, the defined benefit pension plan has been losing ground in recent years: in 1985, defined benefit pension plans numbered 112,000 in the U.S., compared with just 31,000 in 2003. Funding for the defined benefit pension plan of a company may be undermined if it has financial difficulties, as has happened in recent years to many firms with a defined benefit pension plan.