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Retirement in America: how does it work?

Pension plans, commonly referred to as retirement plans in the USA, may be set-up by employers, insurance companies, trade unions, the government, or other institutions. Retirement plans in the U.S. are defined in tax terms by the Internal Revenue Service (IRS). The basic retirement age is 65 years of age

Social Security Program

Social Security is the federal program that provide funds for many social welfare and social insurance programs. Earnings are tracked throughout a worker's lifetime by their social security number. The amount of the monthly benefit to which the worker is entitled depends upon that earnings record and upon the age at which the retiree chooses to begin receiving benefits.

Social Security Card

You need a Social Security number to get a job, collect Social Security benefits and receive some other government services. Only non citizens authorized to work in the United States by the Department of Homeland Security (DHS) can get a Social Security number.

    What kind of card do you need?
  • Original if you never had a Social Security number
  • Replacement if your original card was lost or stolen
  • Corrected card if you have a card and need a name change, a name correction, or need to change a restrictive legend on your card

There are many social security offices in every US city. Use the office locater to find the closest one to you. If you prefer to apply in your home country before you come to the United States, you may do so when filing an application for an immigrant visa with the U.S. Department of State.

You will need to bring original documents (i.e. passport, drivers license): proving U.S. citizenship, age, and identity.
For non-citizens: documents proving immigration status, work eligibility, age, and identity.
You will also need to fill out an application.

Note: it is not usually necessary to show your Social Security card so it is best to keep it in a safe place with your other important papers.

Age of Eligibility

The basic age of eligibility is 65.
However, full retirement benefits depend on a retiree's year of birth.
Those born before 1938 have a normal retirement age of 65. Normal retirement age increases by two months for each ensuing year of birth until the 1943 year of birth. At that point, retirement age is 66 years old until the year of birth of 1955. Thereafter, the normal retirement age increases again by two months for each year ending in the 1960 year of birth, when normal retirement age is 67 years old.

It is possible to start benefits before normal retirement age at a reduced benefit. This reduction is 5/9 of 1% for each month up to 36 and then 5/12 of 1% for each additional month. This formula gives:
  • an 80% benefit at age 62 for a worker with a normal retirement age of 65
  • a 75% benefit at age 62 for a worker with a normal retirement age of 66
  • and a 70% benefit at age 62 for a worker with a normal retirement age of 67.

  • It is also possible to delay starting retirement benefits. Retirement credits increase their benefit until they reach age 70.

    How to Apply

    Applying for Social Security retirement benefits is very easy. You may apply online or by walking into your local Social Security office.


    Benefits vary widely depending on the amount contributed throughout the workers life, as well as how long they contributed. Benefits are complicated and may be compromised by many factors including if there is a spouse, government employment, and other variables. To calculate benefits, the Primary Insurance Amount (PIA), must be calculated. This is the average of the highest 35 years of the worker's covered earnings (before deduction for FICA). To make this process easier, there are many useful calculators to evaluate how much of a benefit you can expect, the best being the official Social Security Retirement Calculator.

    To give an example of possible benefits, let's use the example of Mr. Smith. If Mr. Smith retires at 65 and has 42 years with some Social Security covered earnings, he could be eligible for as much $1,615 per month.

    Private Retirement Plans

    Many people also prepare for retirement by setting up a private pension fund. This is often set-up with the company you are employed with. Companies may use a good retirement plan as a benefit of working for their company. These plans can also be set-up independently with a private firm.

    Foreign individuals are able to easily invest in private funds individually, or if they are employed with an American company that feature a private pension program.

    There are three basic types of plans: defined contribution plan, defined benefit plans, and hybrid and cash balance plans.

    Defined Contribution Plan

    A defined contribution plan is an employer-sponsored plan with an individual account for each participant. Money is contributed by the employer and directly deducted from the employee's salary. Employee contribution may be matched by the company. The IRS regulates the total deferral amount. Currently, if the employee is the sole contributor, $16,500 can be deferred per year. Although for participants age 50 or older may make additional contributions up to amount of $5,500. This is the dominant form of plan in the private sector.

    The participant is responsible for selecting the types of investments to make. They may choose a small number of pre-determined mutual funds, individual stocks, or other securities. The funds in such plans may not be withdrawn without penalty until the investor reaches retirement age.

    Examples of Defined contribution plan include 401(k), Individual Retirement Account (IRA), and profit sharing plans.


    IRC 401(k) plans are the most popular type of retirement plan used today. Employers can help their employee save for retirement while reducing taxable income, and workers can choose to deposit part of their earnings into a 401(k) account and not pay income tax on it until the money is later withdrawn in retirement. Interest earned on money in a 401(k) account is never taxed before funds are withdrawn. Employers may choose, and often do, to match contributions that workers make.

    401(k) accounts are typically administered by the employer. In the typical "participant-directed" plan, the employee may select from different kinds of investment options. Most companies plans also offer the option to purchase the company's stock.


    An individual retirement arrangement is a broad term generally referring to an investing tool used by individuals to earn and earmark funds for retirement.

      Specific types include:
    • Roth IRA - contributions are made with after-tax assets, meaning all transactions within the IRA have no tax impact, and withdrawals are usually tax-free.
    • Traditional IRA - contributions are often tax-deductible (often simplified as "money is deposited before tax" or "contributions are made with pre-tax assets"). All transactions and earnings within the IRA have no tax impact, and withdrawals at retirement are taxed as income (except for those portions of the withdrawal corresponding to contributions that were not deducted). Depending upon the nature of the contribution, a traditional IRA may be referred to as a "deductible IRA" or a "non-deductible IRA."
    • SEP IRA - this type refers to a provision that allows an employer (typically a small business or self-employed individual) to make retirement plan contributions into a Traditional IRA established in the employee's name, instead of to a pension fund in the company's name.
    • SIMPLE IRA - a simplified employee pension plan that allows both employer and employee contributions, similar to a 401(k) plan, but with lower contribution limits and simpler (and cheaper) administration.
    • Self-Directed IRA - a self-directed IRA that permits the account holder to make investments on behalf of the retirement plan.

    Profit Sharing Plans

    This type of plan refers to various incentive plans that provide direct or indirect payments to employees that depend on company's profitability in addition to employees' regular salary and bonuses. In publicly traded companies these plans typically amount to allocation of shares to employees.

    These plans are based on predetermined economic sharing rules that define the split of gains between the company as a principal, and the employee as an agent. For example, if the profits are x, the principal and agent might agree on a sharing rule s(x). The agent would receive s(x) and the principal will receive the residual gain x-s(x).

    These are often used in conjunction with 401(k) plans.

    Defined Benefit Plans

    A defined benefit plan pays a benefit that will be paid upon retirement. A monthly benefit is allotted equal to the number of years worked multiplied by the member's salary at retirement multiplied by a factor known as the accrual rate. At a minimum, benefits are payable as a Single Life Annuity (SLA) for single participants, or as a Qualified Joint and Survivor Annuity (QJSA) for married participants. These funds are paid at retirement and may be adjusted for an earlier or later start. A lump sum distribution may be available in some cases.

    Defined benefit plans may be either funded or unfunded.

    In a funded plan, contributions from the employer and participants are invested into a trust fund dedicated solely to paying benefits to retirees. The future returns on the investments is not known in advance, so there is no guarantee that a given level of contributions will meet future obligations. Therefore, fund assets and liabilities are regularly reviewed by an actuary in a process known as valuation. A defined benefit plan is required to maintain adequate funding if it is to remain qualified.

    In an unfunded plan, no funds are set aside for the specific purpose of paying benefits. The benefits to be paid are met immediately by contributions to the plan or by general assets. Most government-run retirement plans, including Social Security, are unfunded, with benefits being paid directly out of current taxes and Social Security contributions.

    Hybrid and Cash Balance Plans

    Hybrid plans combine the positives of defined benefit and defined contribution plans. They are treated as defined benefit plans for tax, accounting, and regulatory purposes. The investment risk is also shouldered by the plan sponsor. However, like a defined contribution plan, benefits are expressed in the terms of a notional account balance, and are usually paid as cash balances upon termination of employment. A typical hybrid design is the Cash Balance Plan, where the employee's notional account balance grows by a defined rate of interest and annual employer contribution.


    There are a plethora of companies from which to choose to fund your retirement. (Note that if planning for your retirement through your place of employment, your options may be more limited.)


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