Obvious benefit for Employees but why do employers engage in pension plans? (currently they have tax benefits but they didn’t originally)Alternative Ways to Organize Retirement SavingsoWhy should employers act as financial intermediaries rather than leaving retirement savings to specialized institutionsPension Plans as Performance Bond-oEmployers can use PP as incentive devicesoBond will increase productivity of workers Defined Benefit Plans-Sponsor promises participants a certain level of benefits when they retire. The Benefits formula-10/7/201910
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oPension annuity= (2% of final year’s pay x years of service) – (.5 x Social Security benefit)oDefined benefit plan-Adv. Face no investment riskDisadv. Lose pension if leave job or sponsor could defaultProtection against inflation risk-oNo explicit protection from inflation after retirement since annuity is fixed oSponsors in the past have voluntarily increased annuities to compensate for inflation- this is implicit protectionVesting and Portability-oVesting rules- determine your right to a pension if you leave the job. The rules vary from plan to plano“cliff vesting”- if you leave job in less than 5 years you don’t get pension, but if you leave after 5 you get retirement benefitsoalternative is to have a trade union sponsor the pension fund (like for truckers)- this is a portable pension: one that can be transferred from job to jobFunding-oDefault risk of defined benefit plan depends on degree of funding and on external guaranteesDefined Contribution Plans-A pension plan in which the sponsor makes specified contributions to the account of the participantUsually proportional to earningsHow do they compare with defined benefit plans?oRisk- level of retirement income is unknownoDon’t have to worry about sponsor defaulting howeveroVesting is automatic and immediate- doesn’t matter when u leave401K Plans-ovoluntary tax deferred contribution by participantProfit-Sharing Plans and ESOPs-oInstead of contributing a set amount to the account of the participant, the employer will contribution a portion of the profitsoCan be in cash or in stock (if stock this is called employee stock ownership plan)Cash Balance PlansDefined benefit plan in which benefits are based on contributions over the life of the planNo actual accounts, the account is just an “IOU” from employerMore attractive to workers who switch from job to jobThe Management of Pension Funds-Most sponsors use trustee to invest contributions provided by the sponsor and pay benefits to retired participantsAdv. To having plans managed by outside trusteeoLower transaction costsoGreater expertise and has equipment and personneloGreater expertise with dealing with regulationsoEnhances credibility of plan 10/7/201911
Regulation of Pension PlansERISA-oEmployee Retirement income security act- page 281Pension Insurance- oPension Benefit Guarantee corporation- est. by ERISA. Insure defined
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