Chapter 4 - Pension Plans Flashcards
DB pension plans
defined benefit pension plan
cash balance plan
DC pension plan
Money purchase plan
Target benefit pension plan
ERISA Mandatory funding requirement
plan must be fully funded at 100% of PV of benefits every year
Mandatory funding for DB plans
plan sponsor must fund the plan on an annual basis with an amount determined by actuaries
Mandatory funding for DC plans is based on
the plan document
In-service withdraws (applies to DB and DC)
any withdraw while an EE is still a participant in the plan
2006 Pension Protection Act
allowed for in service withdraws fter the age of 62
SECURE act
reduced the age of allowable in service withdraws to 59 and 1/2
Limited investment in ER securites
No more than 10% of investment can be in ER securities. This protects the ability of the plan to pay promised benefits
Required for spousal coverage
options are available to cover a spouse but not mandatory
Limits on life Insurance
No more than 25% of the plan can be funded by life insurance. Life insurance is not the primary focus of the plan
Differences in DB and DC plans (6)
- use of an actuary
- investment risk
- pension benefit guarantee corporation
- benefits
- credit for prior service
- permitted disparity/social security integration
Difference in use of actuary
DC plan does not need an actuary and DB plan does need one to estimate owed debt at the end of the plan year
Actuaries set expectations based on ____ (6) and the price is correlated how with each
expected inflation (positive)
wage increases (positive)
life expectancy (positive)
investment returns (negative)
mortality (negative)
forfeiture turnover (negative)
Differences in Investment risk
In a DB plan ER bears the investment risk and in a DC plan the EE bears the investment risk
Differences in Pension Benefit Guarantee Corporation (PBGC)
only covers DB Plans not DC Plans. It is a federal program that insures DB plans.
How does the PBGC work?
premiums are paid for by firms offering pensions
the max benefit is $6,204.55
Difference in Benefits (calculation of accrued benefits)
DB plan = PV of expected vested future payments
DC plan = vested acct balance of a qualified plan
What is accrued benefit
way to calculate the total benefits an EE has earned over their employment
What is the formula to calculate DB pension plan benefits
percentage (usually low) x yrs of service x final earnings
Difference in credit for prior service
only available for DB plans not DC plans.
Is when an ER can give a new EE credit for prior service if they had a DB plan with past ER and lost some of those benefits
definition permitted disparity/social security integration
helps offset social security’s discriminatory nature towards lower income EEs
Difference in permitted disparity/social security integration
DB can use excess and offset method while DC can only use excess method
Excess Method
the goal is to increase benefits EEs with compensation > covered comp limit.
this is limited to the lesser of .75 of years of service OR the benefit % for earnings below the covered compensation limit per yr of service
Offset method
the goal is to reduce pension benefits for lower-compensated EEs.
limited to the lesser of 1.75% per year of compensation or -.75%
- Traditional DB pension plan characteristics
- mandatory funding based ona ctuarial analysis
- 3 ways to calculate benefit (flat amount, flat % formula, Unit credit formula)
- commingled accounts
- favors older EEs/ Longer term EEs
flat amount calculation of benefits
every EE recieves the same benefit regardless of income
flat percentage formula calculation of benefits
takes a specified % of annual compensation
unit credit formula calculation of benefits
yrs of service x a percentage x total final compensation
total final compensation can be (avg income of last 3 yrs or highest of last 3 yrs income)
Commingled accounts
ER operates the fund and account. EE has no liability or responsibility
- Defined Benefit Cash Balance Plan Characteristics
- mandatory funding
- based on annual guaranteed contribution rate + guaranteed earnings on the contribution
- vesting is ALWAYS 3yr cliff
- a traditional plan can be converted to the cash balance
- two parts to plan: pay credit and interest credit
Defined contribution Money Purchase Plan Characteristics
- mandatory annual funding of a fixed % of EE compensation limited to 25%
- participant bears the investment risk
- EE has separate accts from ER
- favors younger participants bc they can ride out volatility
- do not require actuarial analysis (no minimum funding needed)
Defined Contribution Target Benefits Plan Characteristics
- type of money purchase plan
- contribution based on EE age
- goal is to provide traditional benefits
- EE bears the investment risk
- favors older EEs
