A pension is an important component of retirement income. If you participate in a private pension plan operated by your employer or wish to enroll in one, understanding how such a plan works is important. Private pension plans are subject to the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. Rules under this Act apply for plan years after January 1, 1975. Not all private pension plans are alike. Some basic concepts of pension plans are explained below.

Types of plans: Pension plans belong to two main types, defined benefit plans and defined contribution plans. In a defined benefits plan, the benefit that is paid is fixed or defined. It may be based on your salary or on a formula that links your years of service, age and salary. Contributions to the pension plan are made by your employer. Your benefit is in the form of an annuity that is paid out in equal monthly installments once you start claiming benefits.

In a defined contribution plan, it is the amount contributed that is fixed. The contribution may be made by you and/or your employer and is based on a percentage of your salary. An example of a defined contribution plans is a 401(k) account. You can decide how funds are invested by choosing from a set of investment options given in the plan. The benefit received is the net value of the total amount invested, the gain /loss from investments less related fees. It can be paid in a lump sum or in monthly payments.

Some employers offer a cash balance plan that incorporates features of both defined benefit and contribution plans. Plan funds are contributed by the employer. The benefit is defined as an account balance. As in a defined contribution plan, the participant may, with spousal consent, choose to collect the benefit in a lump sum or in monthly installments.

Plan enrollment: To join a pension plan, you are generally required to have a minimum age of 21 years and 1year of service. Check the rules of your employer’s plan, especially its vesting requirements Vesting relates to your right to receive funds invested in the plan without forfeiture. Employee contributions are automatically vested. Some employers require that you complete a minimum service period of 2 years before employer contributions are vested. Others provide for a stepped up vesting process.

By definition, contribution plans set up as Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) 401(k) and Safe Harbor 401(k) are automatically vested .The Summary Plan Description (SPD) provided to you upon enrollment provides the main features and rules of your pension plan. Find out who bears fiduciary responsibility for your plan.

Pension plan changes: Certain life events such as death, divorce or marriage can affect your pension plan, particularly relating to survivor benefits. Sometimes, part of your retirement benefits may be channeled to a former spouse or children as a result of a court-ordered directive.

Your employer may also introduce changes relating to future contribution rates. While this can affect the total amount invested, it will not reduce the benefits you have accumulated up to that time. By law, the plan administrator should provide advance notice before making any changes to your pension plan including its termination. Call the Labor Dept toll free at 1.866.444.3272 for clarification.

Pension benefits: You become eligible to receive your pension benefits upon reaching the later of the retirement age at 65 years or 10 years of service or job termination. A pension plan set up as a 401(k) may allow withdrawal while yet employed if you have reached 59 ½ years or have suffered hardship. Check your plan rules relating to job termination, early retirement, normal retirement and continuation of work during retirement years. Benefits are paid only after you submit a duly completed claim form.

The Pension Benefits Guarantee Corporation (PBGC) guarantees payments of private retirement plans that are underfunded if they have been set up as defined benefit plans. This would happen if a plan is terminated due to employer bankruptcy or if a division of a company is closed. The PBGC then takes over as the trustee of the pension plan. Benefits paid out may be less than what was initially stated and comprises plan funds as well as those of PBGC.

Transferability: Most defined contribution plans permit rollover of funds to a pension plan of a new employer if you leave before retirement. If the balance in your account is more than $1000, the plan administration is required to transfer the funds to an Individual Retirement Account (IRA) that preserves the principal. In the case of a defined benefit plan, you may have to let funds remain in the original plan until you reach retirement age. Should you decide to not invest these funds and are not yet 59 ½ years, you have to pay income taxes and penalties on the funds withdrawn.

Review: It is in your interest to periodically review your plan. Most plans provide for changes to be made only once in six months. This is when you can change the contribution rate, opt out of the plan or request for other permitted plan changes. Once a year, your plan administrator will provide your plan’s summary annual report and an account statement. Ensure that your name, date of birth, hire date, beneficiary information and other relevant details are correct. Your pension plan is important enough to merit this attention.