Academic journal article Monthly Labor Review

Distribution of Retirement Income Benefits: Lump Sums Have Become More Popular as an Alternative to Annuity Payments in Defined Benefit Retirement Plans and Remain the Prevalent Distribution Option in Defined Contribution Plans. (Distribution of Retirement Income)

Academic journal article Monthly Labor Review

Distribution of Retirement Income Benefits: Lump Sums Have Become More Popular as an Alternative to Annuity Payments in Defined Benefit Retirement Plans and Remain the Prevalent Distribution Option in Defined Contribution Plans. (Distribution of Retirement Income)

Article excerpt

Benefits under the two kinds of retirement plans offered by U.S. private industry--defined benefit and defined contribution plans--may be distributed to an individual in a variety of ways. Quite often, the individual will have a choice of payment options at retirement. According to a 2000 BLS survey of employee benefits in private industry, (1) virtually all employees under defined benefit plans had a joint and survivor annuity available at retirement, a feature that provides a portion of the retiree's annuity to the spouse after the retiree dies. (2) (See table 1.) Approximately three-fourths of the participants with such a benefit were given a choice of various options; for example, 50 percent, 67 percent, or 100 percent of the retiree's benefit could be provided to the spouse. Although traditionally, defined benefit plans have paid out benefits to the employee and spouse in the form of an annuity, more and more plans in recent years have been offering some type of lump-sum benefit as a payment option. The survey indicated that 44 percent of all workers in defined benefit plans were offered some type of lump-sum benefit option.

Defined contribution plans come in several varieties, and, as with defined benefit plans, their benefits may be distributed in a number of ways. The most prevalent type of defined contribution plan is the savings and thrift plan, followed by the profit-sharing plan and money purchase plan. (3) In 1978, section 401(k) was added to the Internal Revenue Code, allowing employees to make pretax contributions into an employer-sponsored defined contribution plan through salary reduction agreements. These types of arrangements are called 401 (k) plans. (4) Virtually all savings and thrift plans include a 401(k) feature; certain other types of defined contribution plans may include such a feature as well.

Regardless of the type of defined contribution plan, the payment options at retirement are similar. Most data in this article are based on savings and thrift plans, primarily because of their prevalence. Lump-sum payment, by far the most widespread method of distribution of retirement income, was provided as an option to 87 percent of all participants in savings and thrift plans. (See table 2.) Installments paid out over a specified period were available to 54 percent of participants, while 34 percent had an annuity option.

Defined benefit plans

Under a defined benefit plan, the employer guarantees the employee's future benefit on the basis of a predetermined formula, usually tied to the employee's earnings. Traditionally, there have been three types of defined benefit formulas. A final-pay formula, the most prevalent type, is based on a percentage of the average earnings of an individual during a given number of years at the end of the work career, the period when the individual's earnings are typically highest. For example, a plan may pay 1.5 percent of the individual's average earnings during the highest 5 of the last 10 years of service, multiplied by each year of service. A career-average-pay formula is based on the individual's earnings over his or her entire career. Such a formula might be stated, for example, as 2.0 percent of the individual's earnings for each year worked. The third and final type of traditional formula provides a flat dollar amount for each year worked-such as $30 per month--times the number of years of service.

In recent years, a new type of defined benefit plan has become more prominent. A cash balance plan credits a dollar amount into a hypothetical employee account, usually on the basis of a percentage of the participant's earnings. Each year, the value of the account is credited with an interest rate specified by the plan. While similar to a defined contribution plan in many respects, a cash balance plan is considered a defined benefit plan, because it guarantees future benefits. Both traditional defined benefit plans and cash balance plans have various methods for distributing benefits at retirement. …

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