Midterm: Pension and Plan Essay

Benefit midterm exam

Hui Yu
03/35/2015

1. In a defined benefit plan, each employee’s future benefit is determined by a specific formula, and the plan provides a nominal level of benefits on retirement. Normally, the earnings history, length of service or both decide the promised benefit. Traditionally, many governmental and public entities, as well as a larger number of companies, provided defined benefit plans, sometime as a mean of compensating employees instead of increased pay. There are several general characteristics of defined benefit plan:（1）The benefit is defined and known in advanced. (2) Employers shoulder the financial risk. (3) It would provide higher benefits for career employees. (4) It requires service provided by actuary and investment professionals. (5) The cost is uncertain.
Typically，there are three types of defined benefit plan. (1) Flat benefit plan. Employees are paid a flat-dollar amount for every year of service recognized under this plan. (2) Career average plan. Under this plan, employees’ retirement benefit is a percentage of the career-average earnings, multiplied by the number of service years. The career-average earnings can be calculated by adding up all earning and dividing by all years worked. (3) Final average plan. This plan focuses on average earnings during a specific number of years at the end of a participant’s career. The benefit equals a percentage of the employee’s final average earnings, multiplied by the number of service years. Final average plan is an effective way to provide employees with greatest inflation protects, but at the same time, it brings higher cost to company, because this is presumably the time when earnings are highest.
In a defined contribution plan, employers set up individual accounts for employees and make annual or periodic contributions to these accounts. The benefits at retirement equal to the money accumulated in individual account. The current contribution is guaranteed but the benefits at retirement are not guaranteed. The contributions stated as a percentage of the employee’s salary and related to service years can come from employers, employees or both. The general characteristics of defined contribution plan are stated as following: (1) The employee account are individual, not joint as in defined contribution plan. (2) The investment risk is on employees. (3) Account balance is available on retirement or termination, death, disability or sometimes in-service. (4) Benefit or account balance can be impacted by several factors, such as the begin age of contribution, length of participation and amounts contributed by the employer and/or employee.
There are four types of defined contribution plan. (1) Deferred profit sharing. Deferred profit sharing plan is established by an employer to provide for the “participation in profit” by employees and it must have predetermined formula for allocating the contributions to participants (2) 401(k) arrangement. Under a cash or deferred arrangement, employees are allowed to elect to have portion of his or her compensation contributed to a qualified retirement plan. Typically, the employee contribution is treated not as current income but as a reduction in salary, which is then paid into the plan. (3) Employee stock ownership plan. Under this plan, companies share ownership with employees without requiring the employees to invest their own money. With an ESOP, shares of company stock are contributed to the ESOP on behalf of the employees. (4) Cash Balance plan. Sometimes cash balance plan is called a “hybrid” plan because it mixes characteristics of defined benefit and defined contribution plans.
The differences between defined benefit plan and defined contribution plan would affect company’s choice of benefit strategy. The differences and influences are stated as followings: (1) From the perspective of achievement of objectives, DB plan rewards long service and late careers hires and

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