The Nature of Pension Plans with Focus on Defined Contribution Pension Plans - Research Paper Example

? The Nature of Pension Plans with Focus on Defined Contribution Pension Plans and Defined Benefit Pension Plans Affiliation Author Note Author note with more information about affiliation, research grants, conflict of interest and how to contact The Nature of Pension Plans with Focus on Defined Contribution Pension Plans and Defined Benefit Pension Plans Nature of Pension Plan: Pension plan is a kind of arrangement by which an employer offers payments or benefits to workers after they retire? in return for the service they provided while they were working. It is designed to provide income to people for the period of their retirement years. The amount is collected by setting aside funds for the period of a workers working years? so that at retirement the gathered funds plus earnings from investment on those funds are obtainable to replace wages. “Actually, an individual who periodically invests in stocks, bonds, certificates of deposit (CDs), or other investments for the purpose of saving for retirement is establishing a personal pension fund. Often, such individual plans take the form of individual retirement accounts (IRAs) to take advantage of tax breaks offered by that arrangement” (Part A: The nature of Pension Plans n.d. p. 1010). Pension funds must be controlled. They have managerial responsibilities? create decisions on the subject of benefits and entitlements and, in some cases, guarantee that long-term duties are met in the circumstance of uncertainty and risk. As such, it is debatable that pension funds are like other financial organizations, which have objectives and goals in addition to procedures that help attain these objectives and goals are realized. Pension plans often increase productivity, decrease turnover, gratify union demands and permit employers to fight in the labor market. Corporations set up pension plans for various reasons. Sponsorship of such plans provides workers with an amount of security during the time of retirement and accomplishes a moral duty felt by many employers. This security also encourages the level of job satisfaction and possibly loyalty that might increase productivity and decrease turnover. Defined Contribution Plans: A defined-contribution plan is a kind of plan in which workers’ benefit for the period of retirement depends on the contributions made as well as the performance of the investment of the assets in his or her account, rather than on the workers’ years of service or history of earnings. Like a classic savings account, a defined-contribution account includes a particular balance at any given time, which is up to the market value of the assets gathered in the account. Unlike in the case of a defined-benefit plan, workers have significant control over how the donations and contributions to their plan are invested and may normally prefer an assortment of stocks (frequently including company stock), mutual funds, bonds, and other investment vehicles. These pension plans assure fixed yearly contributions to the pension fund (say, 5% of the workers pay). Employees prefer (from designated alternatives) where funds are invested generally? that is? in fixed-income or stocks securities. Retirement disburse depends on the volume of the fund available during retirement. In a defined contribution plan, investment rewards and investment risks are assumed by every worker or retiree and not by the employer or sponsor. This risk could be considerable. Based on simulations from safety returns over the 20th century across 16 states, there can be seen substantial variation in pension fund ratios across both the country as well as different time periods in the same country. “There are several types of defined contribution plans, including money purchase plans, profit-sharing plans, 401(k) arrangements, savings plans, and employee stock ownership plans (ESOPs). These are described briefly below” (Defined Benefits and Defined Contribution Plans: Understanding the Differences, n.d. p. 2). Advantages: Observe money and develop portfolio? here what one sees is what he or she gets. Control over the money and savings in the plan. Disadvantages: Retirement profits are completely dependent on how the market performs during the vested time. Even a worker who has no involvement in finances wants to be involved with the portfolio. Defined Benefit Pension Plans: In a defined-benefit plan, the company guarantees that the worker will get a definite quantity of benefit upon retirement, regardless of the performance of the basic investment pool. When setting aside money to fund a pension plan, the improbability regarding the rate of return on plan assets is but one of the several doubts inherent in a defined benefit plan. Worker turnover influences the number of workers who eventually will become qualified for retirement benefits. The age at which workers will decide to retire with life expectancies will impact both the part of the retirement stage and the quantity of the benefits. Price rises, future compensation stages and interest rates also have clear influence on ultimate benefits. In the financial sense, a defined benefit pension plan is a main kind of pension plan in which a company promises a particular monthly benefit on retirement that is prearranged by a rule based on the workers earnings history as well as tenure of age and service, rather than depending on savings returns. It is 'defined' in the sense that the method for calculating the employer's contribution is known in advance. “The key elements of a defined benefit pension plan are: 1. The employer’s obligation to pay retirement benefits in the future. 2. The plan assets set aside by the employer from which to pay the retirement benefits in the future. 3. The periodic expense of having a pension plan” (Part A: The nature of Pension Plans, n.d. p. 1014). A pension formula naturally defines retirement payment founded on the employees. It includes years of service, annual returns as well as the age factor. Pension profits and losses occur when the pension obligation is higher or lower than estimated and also when the return on planned assets is lower or higher than expected. The main advantage of benefit pension plans includes: The retirement income is independent of the performance of market and adjusted in case of rise in prices. Retirement income is comparatively high for the amount of employee contribution. The high income years before retirement really work to the advantages of employees. Disadvantages: The main risk with having a non-government defined benefit plan is that there is a chance of the pension not being funded properly. Some DBP’s only permit a part of the pension to be transferred to a spouse if the beneficiary passes away. While an RRSP is extra flexible and facilitates the transfer of every asset. Conclusion: Generally, a worker does not have an option as to choose to join in a defined contribution plan or benefit plan. It is generally one or the other depending on the business. Defined contribution plans are growing extra popular, as they prove to be less risky to the business and the workers as well. Reference List Defined Benefits and Defined Contribution Plans: Understanding the Differences. (n.d). Retrieved from http://www.ebri.org/pdf/publications/books/fundamentals/fund05.pdf Part A: The nature of Pension Plans. (n.d). Print. Read More