Picking between Defined Benefit Plans & Defined Contribution Plans Jon Forman Alfred P. Murrah Professor of Law University of Oklahoma August 15, 2005Slide 2
Overview Background Types of Plans Comparisons between Defined Benefit and Defined Contribution PlansSlide 3
Background Social Security Poverty Levels Aging of AmericaSlide 4
How Much Does Social Security Pay? www.ssa.gov/OACT/COLA/colaeffect.htmlSlide 5
How do Social Security benefits contrast with profit? Resigned specialist age 65, 2005 National Academy of Social Insurance, Social Security Finances: A Primer (2005)Slide 6
American Academy of Actuaries (2005), accessible at <http://www.actuary.org/pdf/socialsecurity/medicare_socsec_briefing_april05.pdf>.Slide 7
2005 Poverty Levels Single people – $9,570 ($798/month) Married couples – $12,830 ($1,070/month) http://aspe.hhs.gov/neediness/05poverty.shtmlSlide 8
Aging of America Americans are living longer yet resigning prior Life anticipation for a male conceived in 1940 was only 61.4 years today it is 73.9 years Also, a man achieving age 65 in 1940 could hope to experience an additional 11.9 years however a man achieving 65 in the year 2000 could hope to experience an additional 15.9 yearsSlide 9
Aging of America Increasing rate of Americans will make due to seniority. For instance, albeit only 54 percent of men conceived in 1875 made due from age 21 to age 65 in 1940 Almost 83 percent of men conceived in 1985 are relied upon to get by from age 21 to age 65 in 2050 A turning gray of AmericaSlide 10
Aging of America Trend toward prior and prior retirement Average age at which specialists start accepting their Social Security retirement benefits tumbled from 68.7 years of age in 1940 to 63.6 years of age in 2002 Labor power interest rates for the elderly have likewise droppedSlide 11
Bureau of Labor Statistics, Labor Force Statistics from the Current Population Survey: Civilian Labor Force Participation Rate (2004), accessible at <http://data.bls.gov/labjava/outside.jsp?survey=ln>.Slide 12
Three Basic Types of Plans Defined advantage arranges Defined commitment arranges Also, half breed arrangesSlide 13
What is a Defined Benefit Plan? Boss guarantees representatives a particular advantage at retirement To give that advantage, the business makes installments into a trust store and makes withdrawals from the trust reserve Employer commitments depend on actuarial valuationsSlide 14
Defined Benefit Plan Employer bears the greater part of the venture dangers and obligations Typical arrangement gives every specialist a particular yearly retirement advantage that is fixing to the laborer\'s last normal pay and number of years of administrationSlide 15
Defined Benefit Plan For instance, an arrangement may give that a specialist\'s yearly retirement advantage is equivalent to 2% times years of administration, times last normal pay B = 2% × yos × fap Final-normal pay equationSlide 16
Defined Benefit Plan Worker with 30 years of administration would get 60 percent of her pre-retirement profit Worker procuring $50,000 would get $30,000-a-year annuity B = $30,000 = 60% × $50,000 = 60% × fap = 2 percent × 30 yos × $50,000 fapSlide 17
Defined Benefit Plan Effect of swelling on genuine estimation of retirement salarySlide 18
Defined Benefit Plan Benefits are "backloaded" Disproportionately support more seasoned laborersSlide 19
Only 3 approaches to alter an underfunded Defined Benefit Plan Raise Contributions Cut Benefits Increase Investment ReturnsSlide 20
What is a Defined Contribution Plan? Singular record arrangement Employer normally contributes a predefined rate of the laborer\'s compensation to an individual speculation represent the specialist Owned by representative Benefits in view of commitments and venture incomeSlide 21
Defined Contribution Plan For instance, manager may contribute 10% of yearly pay Under such an arrangement, a laborer who earned $30,000 in a given year would have $3,000 added to her record $3,000 = 10% × $30,000 Benefit at retirement in light of commitments, in addition to venture incomeSlide 22
Defined Contribution Plan Money buy annuity arranges 401(k) and 403(b) plans permit specialists to pick between accepting money right now or conceding tax collection by setting the cash in a retirement account Profit-sharing arrangements & stock extra arrangesSlide 23
What is a Hybrid Plan? "Half and half" arranges blend components of characterized advantage and characterized commitment anticipates illustration, a money equalization arrangement is a characterized advantage arrange for that resembles a characterized commitment arrangement Cash parity arranges aggregate, with premium, a speculative record parity for every memberSlide 24
Hybrid Plan For instance, a basic money parity arrangement may designate 10% of compensation to every laborer\'s record every year and acknowledge the record for 7% enthusiasm on the parity in the record Under such an arrangement, a specialist who earned $30,000 in a given year would get a yearly money parity credit of $3,000 = 10% × $30,000 Plus a premium credit of 7% of the parity in her theoretical record as of the start of the yearSlide 25
Hybrid Plan Another basic methodology is to offer a mix of characterized advantage and characterized commitment gets ready for instance, numerous organizations with customary characterized advantage arranges have as of late included 401(k) plansSlide 26
Defined Benefit Plans Benefits dictated by set equation (e.g., 2% × years of administration × last normal pay) Funding adaptability Defined Contribution Plans Benefits controlled by commitments and venture income (e.g., 10% × yearly pay) Possible tact in subsidizing ComparisonsSlide 27
Defined Benefit Plans Reward more seasoned and long administration representatives (backloaded) Financial punishments for working past ordinary retirement age Defined Contribution Plans Significant collections at more youthful ages No disincentives for working past typical retirement age Comparisons, cont.Slide 28
Comparisons, cont. In view of Ron Gebhardtsbauer, declaration before the Senate Committee on Health, Education, Labor, and Pensions (September 21, 1999)Slide 29
Defined Benefit Plans Long vesting period (e.g., 5 years) Employer bears the venture hazard Employee has no speculation attentiveness High rates of return Defined Contribution Plans Often a short vesting period (e.g., 1 year) Employee bears the venture hazard Employee has speculation circumspection Lower rates of return Comparisons, cont.Slide 30
Defined Benefit Plans Often not convenient Require actuarial valuation Relatively low worker comprehension and gratefulness Defined Contribution Plans Portable Does not require actuarial valuation Relatively high representative comprehension and thankfulness Comparisons, cont.Slide 31
Defined Benefit Plans Unfunded risk presentation Provide benefits focused to salary substitution level Defined Contribution Plans No unfunded obligation introduction Do not give benefits focused to wage substitution level Comparisons, cont.Slide 32
Defined Benefit Plans Usual type of advantage installment is month to month salary (annuity) Employees can\'t acquire Defined Contribution Plans Usual type of advantage installment is singular amount circulation Employees might have the capacity to obtain Comparisons, cont.Slide 33
Possible Transitions from a Defined Benefit Plan to a New Plan Keep the conventional DB plan and include a supplemental DC or half breed arrangement Offer both a DB arrangement and another arrangement Close passage to the DB plan and include another arrangementSlide 34
Possible Transitions, cont. Close passage to the DB Plan, include another arrangement, and movement unvested representatives to the new arrangement Freeze the DB Plan at current compensation levels and include another arrangement Terminate the present DB arrange and supplant it with another arrangementSlide 35
Goals for a Pension Plan First, guarantee that each worker wins an important retirement advantage and that long-lasting representatives are ensured a satisfactory salary all through their retirement years Second, have at least work disincentives for representatives coming all through administration Third, be moderate and all around financedSlide 36
Selected Sources Jonathan Barry Forman, Public Pensions: Choosing Between Defined Benefit and Defined Contribution Plans , 1999 (1) Law Review of Michigan State University Detroit College of Law 187-213 (2000). Jonathan Barry Forman, Making Pensions Work , in New York University Review of Employee Benefits and Compensation , Chapter 5, pp. 5-1 to 5-60 (Alvin D. Lurie ed., 2004). Both at http://www.law.ou.edu/profs/forman.shtml
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