Q. 1. Why have private pension plans grown so rapidly since the 1940s?
Although the formal introduction of private pension was made a hundred years ago, it is only in 1940 that the private pension industry has emerged as a major social and economic driving factor in the economy. The early pension plans were initiated by large companies between 1900s to 1940 and some of them were implemented through the help of labor unions. However, most of the companies are not in favor of idea, thus making private pension discretionary and, therefore, unfunded and noncontributory. The growth of the industry have doubled covering four million people paying 100% of the premium. The government realized the favorable contribution of the private pension industry to the Federal tax reserves and, which is greatly needed to fund wartime wage measures. The high profits attributed in private pension encouraged the overall growth of the industry until today (Special Comittee on Aging United States Senate, 1970, p. 7).
Q. 2. Briefly describe the principal tax advantages of qualified pension plans.
Setting up a retirement plan has its benefits not only limited to securing the retirement future of an employee, but also in terms of tax advantages. The benefits work on both the business owner and the employee. When a business shares premium with the employees, they are eligible for tax-deductible and the assets associated with the plans grow tax free. Tax incentives are also given when starting a plan that would relatively reduce its cost. In terms of employee tax advantages, qualified plans may reduce income tax. All of the employee's investments and contributions are not taxable until gains are distributed. The compounded interests also increases on small contributions allowing significantly large retirement savings. For example, a US$50 monthly contribution can yield up to 6% savings, which will accumulate to as much as US$3,506 in savings for a five-year premium terms (Irs.gov, 2012).
Q. 3. Describe the merits of private pensions as a supplement to Social Security benefits and individual savings programs.
The law stipulates that the social security system will remain as the official government mandated social security program that provides pension benefits to retirees. However, private pensions are also regarded as a qualified supplement to social security and the law provided merits of its validity. GAO or the U.S. Government accountability Office made a request to the Congress about the linkage of private pension plans to the social security provisions. The way the government and private pension is tied together is designed to interact together to provide income to employees and their family upon retirement. GAO have noted that private pension should be associated with the social security in terms of cost and benefits. The merits given to the private pension plans are subjective to the provisions of the social security and that the cost and its benefits should be integrated together to compliment the employee's compensation (Gao.gov, 2000).
Q. 4. What are some of the objectives an employer could have for matters concerning the cost of its pension plan?
Since the usual agreement between the employer and employees with regard to private pension premium payments is that either the company will shoulder 100% of the cost of the plan or at least share 50% of it. Therefore, the main concern among employers is the cost. It is always essential for them to consider pension plans that meet their employee's needs, but not as costly as possible. There are certain objectives that employers have concerning the cost of their employee's pension plan. First is the compensation objective meaning, putting cash and employee's benefits in the aggregate (Employee-benefit.blogspot.com, 2008). Another objective is to create a competitive benefit package to attract competitive employees and that is to level their cash and compensation package to the competing firms in the market. However, cost is always the near priority when it comes to designing compensation benefits for their employees, plan flexibility and volatility is always a considering factor.
Q. 5. What are some of the plan design alternatives available to an employer who wishes to achieve maximum tax advantages for a retirement program?
It was discussed earlier that private pension plans has tax advantages. Therefore, a well-designed plan could actually provide a maximum tax advantage particularly the alternatives ones, which are preferred by most employers. Among the many alternative plans, the Cash Balance Plan is regarded as the one with the most advantages when it comes to tax advantage. The plan promises bigger retirement savings and tax deductions. For example, an account is being maintained for the employee, then the company will make annual contributions and since it is a cash balance plan it will gain interest, which will be credited to the account. Another advantage of the Cash Balance plan is that it costs less than the other plan packages and flexible enough when it comes to funding. Other alternative plans that also has maximum tax advantages are Safe Harbor Cross-Tested Plan, 401(k) Plan with salary deferrals and 401(k) with small matching contribution.
Q. 6. Identify the factors that are often considered by employers in setting income-replacement objectives.
In setting income-replacement objectives, the employers need to consider and identify several factors such as demographics. Employers consider demographics in terms of identifying age, aging patterns, wage level, regional population growth and health trends. Another factor is economics, which pertains to issues of funding, social security and Medicare. It also includes cost of healthcare volatility of the investment market and inflation rate. Legal and regulatory environment are also taken into consideration along with utmost considerations to the Pension Protection Act, fee disclosure and transparency (Crane, Heller and Yakoboski, 2008, p. 4-5).
Q. 7. Explain the primary advantages of a defined benefit plan.
Defined benefit plan is a popular choice among employers because of its many advantages. One of them is that defined benefit plan requires less responsibility and lack of choice, besides the fact that employees does not have to put their own money into it. The reason behind that showed in the studies about the 401(k) and other defined benefit plans. It appears that such type of benefit plans can actually deliver retirement income without exerting too much effort into it besides coming to work every day. Payments in defined benefit plan lasts throughout the retirement duration making the budgeting efforts a lot easier. There is also an option wherein the employee can make arrangements to reduce payment so that the spouse would be able to receive income even if the principal plan owner passed away first.
Q. 8. Explain the primary advantages of a defined contribution plan
Defined contribution plan is also known as DCP or the benefit plan in which the employer makes contribution to the plan while in tenure with the company. As soon as the employee reached retirement, the employer will no longer be responsible for contribution. In a nutshell, the employer and the employee are both contributing to fund the benefit plan. There are advantages in this type of benefit plan, one is that the investment has a larger growth potential. It also provides the plan holder with greater control, the plan is also portable and tax advantage is bigger because the earnings and contributions are also classified as tax-differed money.
Q. 9. Explain the ways in which the federal government has encouraged the defined contribution approach.
In the United States, employers are not obliged to sponsor benefit plans. However, the federal government is encouraging the firms to sponsor contribution plan approach because of the number of reasons. One of the primary encouragement is the tax breaks. Tax advantage is the best that the government can offer private firms to keep them to continuously contribute to their employee's pension plan. The IRS set forth rules regarding tax deduction for companies preferring the contribution approach. As a result, the number of defined benefit plan shrank in the past ten years and along with that is the increase in the contribution plans.
Q. 10. Explain how the 1983 Social Security amendments might affect use of the defined benefit approach.
The result of the changes in the Social Security enacted in 1983 impacted the defined benefit approach. One way or another the amendments created a wall for the defined benefit plan approach, it is because the new Social Security provision requires it to be paid in full on a timely basis for the next 75 years. The changes resulted also for the Social Security benefits to be reduced and that particular change created an opportunity for the defined benefit approach. Since the Social Security benefit is no longer as attractive as it was before the amendment, people began to turn to defined benefit approach to fill in the benefits that Social Security cannot provide. The changes presented a bigger advantage for the defined benefit approach. However, the requirement for a full payment hinders employees on the lower wage bracket to afford a second benefit plan because of the added cost.
Q. 11. How may a plan participant protect retirement assets against the erosive effect on purchasing power due to inflation?
Inflation rates greatly affect purchasing power, the value of the goods or service rely on inflation rate in terms of price and demand. When inflation threatens a participant's retirement assets, the next thing to do is to protect those assets from deteriorated value. One of the most effective approach for the participants in protecting their retirement asset is to adopt the "all season" approach. The diversification of all assets classes offers the most robust and prudent protecting strategy and significantly reduces overall volatility. Broad diversification will help mitigate the negative impact of inflation especially for inflation-sensitive assets.
Q. 12. Article Review
The Impact of the Erosion of Retiree Health Benefits on Workers and Retirees
Worker and retirees alike depends on their benefit plans to secure their retirement future and to aid them financially in terms of healthcare. However, number of employers in the private sectors offering health benefits to retirees are decreasing from 22% in 1997 down to 13 percent by 2002 (Fronstin, 2005, p. 1). The reason for the decline is that of the Financial Accounting Standards Board requiring companies to declare the cost of the retiree health benefits in their financial statement. Since the cost of retiree health benefits is staggering and becomes a sore in the eye when laid into the liabilities section of the financial statement, companies have learned to control, reduce the cost and somehow eliminate it completely. Another way that companies was able to eliminate the existence of retiree health benefit cost in their financial statement is to impose a pre-retirement benefit plan that takes effect before the employee reached 65 years old. This article of Paul Fronstin explores the implications of the decline in retiree health benefits and the reason that contributes to the decline on the number of companies offering such benefit.
The article basically focuses on the issue of decline in retiree health benefit offerings, the changes in corporate accounting policies triggered the negative implications upon the retirees. Having that their health benefits were limited by the prevailing policies and requirements made it difficult for the retirees to gain access to healthcare. The choices for the retirees when it comes to healthcare were also limited by the changes and that made it even more difficult for them to keep up with their retirement life. Since geriatric care needed constant health monitoring, therefore, the need for a health benefit is more crucial. The implications of this decline manifests among future retirees having the idea that their healthcare is at risk upon retirement reduces their confidence for their future. Policy makers on the other hand is also facing challenges on how to resolve the problem. However, the bottom line is that the current policies are the ones that is causing the decline in retiree healthcare benefits. The only way to mitigate the problem is to do amendments, to change the way the corporate sector view retirement health benefits as a liability rather than an opportunity to attract competitive employees.
Crane, R. B., Heller, M., & Yakoboski, P. (2008). Defined Contribution Pension Plans in the Public Sector: A Best Practice benchmarch Analysis. TIAA-CREF Institute Whitepaper, 4-5.
Employee-benefit.blogspot.com (2008, January 27). What are the Employer's Objectives. Employee Benefits Blog. Retrieved July 31, 2012, from http://employee-benefit.blogspot.com/2008/01/what-are-employers-objectives_27.html
Fronstin, P. (2005). The Impact of the Erosion of Retiree Health Benefits on Workers and Retirees. issue Brief, (279), 1-20.
Gao.gov (2000, September 14). Implications for Private Pensions. U.S Government Accountability Office. Retrieved July 31, 2012, from http://www.gao.gov/products/HEHS-00-187
Irs.gov (2012, April 23). Lots of Benefits - when you set up an employee retirement plan. IRS. Retrieved July 31, 2012, from http://www.irs.gov/retirement/sponsor/article/0,,id=136475,00.html
Special Comittee on Aging United States Senate (1970). Pension Aspects of the Economics of Aging: Present and Future Roles of Private Pension. A Working Paper in Conjunction with the Overall Study of "Economics of Aging: Towards a Full Share in Abundance", 91(2), 7.