Example research essay topic: Lump Sum Benefit Plans - 2,534 words

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Pension Plans Abstract This paper reviews person plans. It starts ut with classification f person plans and their definitin's. Further, it researches history f person plans worldwide. Finally, the paper examines advantages and disadvantages f each person plan.

Cnclusin f the paper suggest gvernment's rle in person provision. unlike Introduction Main Part Classification f person plans Definitin's History / background f person plans worldwide Advantaged/Disadvantages Gvernment's rle Cnclusin Person plans are classified int tw types: defined contribution (DC) and defined benefit (DB). As the names suggest, in a DC plan a formula determines cntributin's (e. g. , 10 percent f annual wages), whereas in a DB plan a formula defines benefits (e. g. , ne percent f final pay per year f service). In a defined contribution plan, the employee receives at retirement a benefit whse size depends n the accumulated value f the funds in the retirement account.

The employee bears all the investment risk, and the plan sense has n blighting been making its periodic contribution. In a defined benefit plan the plan sense r an insurance company guarantees the formula benefits and thus absorbs the investment risk. In sme countries gvernment's insure a print f defined benefit person prices in the event f create sense bankruptcy; defined contribution benefits are nt, however, insured by gvernment's. With defined benefit plans, there is an important distinction between person plan and the person fund. The plan is the cntr actual arrangement setting ut the rights and bligatin's f all parties; the fund is a separate pl f assets set aside in a trust t provide collateral fr the promised benefits. In defined contribution plans', the value f the benefits and the assets are equal by definition, s the plan is always exactly fully funded.

But in defined benefit plans there need nt be a separate fund, in which case the plan is said t be unfunded. In an unfunded plan, the sense's wn assets back the person claims. In developed nations, the primary function f a retirement income system is t provide people with adequate income in their ld age. Price t the Industrial Revolution, the extended family was the primary institution that performed this function. Elderly family members lived and worked with ff spring n a family-we farm, and all drew a can livelihood frm it.

In many f that's less developed countries, this family-based pattern fr ld age support still hld's true. ver time, urbanization and ther fundamental economic and social changes gave rise t new institutional structures fr the care and support f the elderly in much f the industrialized world. An free-used metaphor fr describing developed countries' retirement income systems is that f the "three-legged stl. " The first leg consists f government-provided ld age assistance and insurance programs, the send is comprised f employer- r last unit-provided pensin's, and the third is individual and family support (James and Vittas). There is substantial variation across households and countries in the mix f these three components f retirement income. Fr instance, government-provided social security benefit generosity varies widely fr the EU and the US.

The be table reports the social security replacement rate, which is defined here as the annual government person benefit as a fraction f final salary. At ne extreme is Italy, where the government-run social security system prvide's a replacement rate greater than 70 percent fr workers earning a wide range f pay. The table shw's the prprtin f the last free covered by an ccupatinal r privately sponsored person plan, and in light f the general social payments it is nt surprising t see that in Italy nly 5 percent f the last free is covered by a voluntarily provided ccupatinal person. At the ther extreme is Australia, where the social security replacement rate is quite lw but 92 percent f workers are covered by a compulsory employer-based person plan (Davis). Country Social Security Retirement Benefit as a Percentage f Final Earnings Percentage f Last Free Covered by a Person Plan Australia 28 t 11 92 (compulsory) Canada 34 41 Denmark 83 t 33 50 France 67 t 45 100 (compulsory) Germany 70 t 59 42 Italy 77 t 73 5 Japan 54 50 Netherlands 66 t 26 83 Sweden 69 t 49 90 Switzerland 82 t 47 90 (compulsory) United Kingdom 50 t 26 50 United States 65 t 40 46 Source: Davis Nte: Replacement rates given fr 1992 and based n final salaries f US$ 20, 000 -US$ 50, 000. In a defined contribution plan, a formula specifies the amount f my that must be contributed t the plan, but nt benefit parts.

Contribution rules usually are a predetermined fraction f salary (e. g. , the employer contributes 10 percent f the employee's annual wages t the plan), although that fraction need nt be constant ver an employee's career. The person fund consists f a set f individual investment accunt's, ne fr each covered employee. Person benefits are nt specified, ther than that at retirement the employee gains access t the that accumulated value f cntributin's and earnings n the cntributin's. These funds can be used t purchase an annuity, r become accessible as a lump sum. In a defined contribution plan, the participating employee frequently has sme click ver bth the level f cntributin's and the way the account is invested.

In principle, cntributin's could be invested in any security, although in practice mst plans limit investment choices t bnd, stock, and my market funds. The employee bears all the investment risk; the retirement account is, by definition, fully funded by the cntributin's, and the employer has n legal blighting been making its periodic cntributin's. Investment policy fr defined contribution assets is essentially the same as fr any tax-qualified individual retirement account. Indeed, the main providers f investment products fr these plans are the mutual funds and insurance companies that als serve the general investment needs f individuals. Therefore in a defined contribution plan much f the task f setting and achieving retirement income replacement gals falls n the employee. In a defined benefit plan, by contrast, the person plan specifies frmula's fr the cash benefits t be paid after retirement.

The benefit formula typically takes int account years f service fr the employer and level f wages r salary (e. g. , the employer pays a retired water an annuity frm retirement t death, the amount f which might be equal t ne percent f the employee's final annual earnings multiplied by years f service). Contribution amunt's are nt specified, and the employer (called the "plan sense") r an insurance company hired by the sense guarantees the benefits and thus absorbs the investment risk. The blighting f the plan sense t pay the promised benefits is similar t a lng-term debt liability f the employer. As measured either by number f plan participants r that assets, the defined benefit frm f pensin's dominates in mst countries and the world. This is s in the United States, although the trend since the mid- 1970 s is fr spnsr's t select the defined contribution frm when starting new plans.

But the tw plan types are nt mutually exclusive. Many spnsr's adpt defined benefit plans as a "primary" plan, in which participation is mandatory, and supplement them with voluntary defined contribution plans. Meter, there are sme plan designs that are "hybrids" combining features f bth plan types. Fr example, in a "cash balance" plan each employee has an individual account that accumulates interest. Each year, emplyee's are tld hw much they have accumulated in their account, and if they leave the firm, they can take that amount with them. If they stay until retirement age, however, they receive an annuity determined by the plan's benefit formula.

A variation n this design is a "flr" plan, which is a defined contribution plan with a guaranteed minimum retirement annuity determined by a defined benefit formula. These plan designs usually take int account the benefits provided by the government-run system. Frm the employee perspective, the may advantage f the defined benefit approach is that it fees plan participants wh stay with the same employer a guaranteed benefit designed t replace their pre-retirement last income. The main defect f private defined benefit plans that they d nt currently for explicit inflation insurance. The may advantages f the defined contribution approach are that it fees participants a mre portable and flexible retirement savings vehicle whse value during the pre-retirement years is easier t understand and measure. In addition, sme emplyee's see the cash-ut access t the defined contribution plan's lump sum accumulation t be attractive.

Hybrid person plans, such as cash-balance r flr plans, are free designed t combine the best features f bth "pure" types. The term "person fund" t represent the accumulation f assets created frm cntributin's and the investment earnings n the cntributin's, less any payments f benefits frm the fund. The person plan is the cntr actual arrangement setting ut the rights and bligatin's f all parties; the fund is a separate pl f assets set aside t provide collateral fr the promised benefits. In defined contribution plans, the value f the benefits equals that f the assets and s the plan is always exactly fully funded. But in defined benefit plans, there is a continuum f possibilities. There may be n assets dedicated t the person plan in a separate fund, in which case the plan is said t be unfunded.

When a separate fund exists but assets are wrth less than the present value f the promised benefits, the plan is underfunded. And if the plan's assets have a market value that exceeds the present value f the plan's liabilities, it is said t be ver funded. Why and hw des funding matter? The assets in a person fund provide collateral fr the benefits promised t the person plan beneficiaries.

A useful anal is that f an equipment trust. In an equipment trust, such as ne set up by an airline t finance the purchase f airplanes, the trust assets serve as specific collateral fr the associated debt blighting. The bring firm's legal liability, however, is nt limited t the value f the collateral. By the same the, if the value f the assets serving as collateral exceeds the amount required t settle the debt blighting, any excess reverts t the bring firm's shareholders. S, fr instance, if the market value f the equipment were t double, this would greatly increase the security f the promised payments, but it would nt increase their size. The residual increase in value accrues t the shareholders f the bring firm.

The related and the shareholders f the firm spring a person plan, the person fund, and the plan beneficiaries is similar t the related and the shareholders f the bring firm in an equipment trust, the equipment serving as collateral, and the equipment-trust lenders. In bth cases, the assets serving as collateral are "encumbered" (i. e. , the firm is nt free t use them fr any ther purpose as lng as that liability remains ut standing), and the liability f the firm is nt limited t the specific collateral. Any residual r "excess" f assets ver promised payments being t the shareholders f the spring firm. Thus, the greater the funding, the mre secure the promised benefits.

However, whether the plan is underfunded, fully funded, r ver funded, the size f the promised benefits des nt change. Why d emplyer's fund their defined benefit plans? Reasons appear t vary across countries. First, funding fees benefit security if there is n government insurance f person benefits, r nly partial insurance.

Emplyee's may demand that the future person prices made t them by their employer be collateralized through a person fund (Mitchell and Smith, 1994). In the United Kingdom, fr example, there is n government person insurance been the minimum guaranteed person f the State Earnings Related Person scheme (SERPs). Person funding in this case prvide's an important cushion f safety fr retirement income (Darwin). Send, sme countries image minimum funding standards by law. These standards seek t insure that promised person benefits are paid even in the event f default by the create sense, and als aim t project the government (and the taxpayer) frm abuse f gvernmentsupplied person insurance. In the United States, fr example, a government person insurance grup called the Person Benefit Guaranty Crpratin (PBGC) must continue person payments feed by defined benefit person plans even if their spring crpratins become bankrupt with an underfunded person plan.

Recent changes in United States person law have required that the PBGC insurance premium must depend n the plan's extent f underfunding, and have als eliminated the possibility f voluntary termination f an underfunded person plan (Ipp lit 1989; Ut gff 1992). In Canada, person insurance was feed nly by a single price fr a limited number f years (Poland). Third, there may be tax incentives fr plan spnsr's t fund their defined benefit plans. As Diet nte's, the tax advantage t person funding in the United States and the United Kingdom stems frm the ability f the sense t earn the pre-tax interest rate n person investments.

It is n accident that in Germany, where emplyer's face a tax disadvantage if they fund their person plan, pensin's are predominantly unfunded (Agreed). Finally, funding a person plan may provide the spring firm with financial "slack" that can be used in case f financial difficulties the firm may face in the future (Be et al. 1987). In the United States, person law all plan spnsr's facing financial distress t draw upn excess person assets by reduced funding r, in the extreme case, voluntary plan termination. The person fund therefore effectively serves as a tax-sheltered contingency fund fr the firm.

A may putative advantage f a defined benefit person plan ver a defined contribution plan is that it projects the employee against investment risk. The economic efficiency f this protection against investment risk is enhanced by the provision f guarantees against default risk. T understand the social welfare gains frm guarantees f person annuities, it is critical t distinguish between emplyee's and investors (stockholders and bondholders) in firms that provide person annuities. The distinction is that, unlike the firm's investors, the emplyee's holding the sense's person liabilities strictly prefer t have the pays n their contracts as insensitive as possible t the default risk f the firm itself.

The function served by a person annuity is fr the beneficiaries t receive a specified benefit upn retirement. That function is less efficiently performed if the contact instead calls fr the benefit t be paid in the just event that the employee retires and the firm is still sent. Even if the spring firm fees an actuarially fair increase in the employee's cash wages t reflect the risk f insolvency, it is still likely that an employee might prefer a person annuity with the least default risk. Emplyee's typically have a large nn-diversified stake in the firm already...

Research essay sample on Lump Sum Benefit Plans