The question “what is a pension?” often arises at the time of an individual’s retirement and is not a simple one. A pension is actually a fund from which a fixed amount of money is contributed throughout an employee’s entire employment years, and from which regular payments are paid out to support the person’s future retirement in the form of fixed monthly payments. This type of fund has been around for years, but only recently has it begun to gain the attention it deserves from both employees and employers.
There are two main types of pension plans. The first is the fully funded pension plan type. Under this plan, the employee makes contributions to the fund at the time of retirement. The money thus contributed is invested and is usually returned upon retirement, providing a steady stream of income. The drawback is that with most employers today, the entire fund is usually drained during the lifetime of the annuitant.
The second type of pension plan is the non-taxable or regulated, plan. Under this type of plan, the company contributes a fixed amount to the funds, and the employee receives a fixed amount in return. The company then makes guaranteed or returnable payments to the employee, depending on the amount that the employee has contributed. Both the employee and the company benefit from this arrangement, with the employee receiving a regular amount that represents his or her career earnings, and the company providing a reliable source of long-term income as long as the worker does not become disabled.
While both of these types of plans have their benefits, they are quite different from a traditional collective bargaining pension plan. Unlike the pension plan of yesteryear, the current system involves two parties that are bound by a contract. The employer typically agrees to pay a percentage of each employee’s future retirement benefits, and the employee contributes to a pooled fund which represents his entire possible retirement earnings. In this way, the employees take advantage of both the tax-deferred and the guarantee features of a collective retirement plan.
Now, let’s examine the actual delivery of the pension plan business process. In the past, when an employee began receiving compensation from the company, there were no penalties for early retirement except for the penalties that still applied to those who retired earlier than the defined benefit deadline. Today, if you begin receiving compensation from your company before your qualified retirement age, you will probably need to file a report with the IRS. You will need to provide a statement that explains the circumstances surrounding your early retirement and the number of cash payments that you will receive upon retirement.
A Much Ado
Along with this information, you will probably be asked to submit a 1099-R form that contains certain standard definitions of pension and retirement benefits paid. One of the key items noted on the W-2 form is the inclusion of the employee’s local taxes. While it may not seem like a big deal now, some employers tend to deduct local taxes before the employee takes his or her pension from the company. In other words, these employers are paying their employees’ local taxes even before they are paid by the company.
In order to avoid the additional tax burden, it makes sense to consult with a CPA prior to submitting any individual tax returns. One thing to keep in mind is that contributions made by a covered entity must appear on the W-2 filing. Individual contributions do not need to be itemized; however, if the employer provides a separate payroll deduction for these contributions, the collective W-2 cannot contain itemized deductions. In the case of a collective plan type, all contributions are subject to itemized deductions.
When the employee’s eligible retirement age is reached, the employee must decide what kind of distribution will be made. In most cases, a distribution is made according to the employee’s pay grade. However, if the administrator prefers a different arrangement, the employee can contact the Plan Administrator. To avoid penalties and future problems, it is important to check the future pay grade regularly and make changes if needed, as appropriate.