Obvious benefit for Employees but why do employers engage in pension plans

Obvious benefit for employees but why do employers

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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 Savings o Why should employers act as financial intermediaries rather than leaving retirement savings to specialized institutions Pension Plans as Performance Bond- o Employers can use PP as incentive devices o Bond will increase productivity of workers Defined Benefit Plans- Sponsor promises participants a certain level of benefits when they retire. The Benefits formula- 10/7/2019 10
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o Pension annuity= (2% of final year’s pay x years of service) – (.5 x Social Security benefit) o Defined benefit plan- Adv. Face no investment risk Disadv. Lose pension if leave job or sponsor could default Protection against inflation risk- o No explicit protection from inflation after retirement since annuity is fixed o Sponsors in the past have voluntarily increased annuities to compensate for inflation- this is implicit protection Vesting and Portability- o Vesting rules- determine your right to a pension if you leave the job. The rules vary from plan to plan o “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 benefits o alternative 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 job Funding- o Default risk of defined benefit plan depends on degree of funding and on external guarantees Defined Contribution Plans- A pension plan in which the sponsor makes specified contributions to the account of the participant Usually proportional to earnings How do they compare with defined benefit plans? o Risk- level of retirement income is unknown o Don’t have to worry about sponsor defaulting however o Vesting is automatic and immediate- doesn’t matter when u leave 401K Plans- o voluntary tax deferred contribution by participant Profit-Sharing Plans and ESOPs- o Instead of contributing a set amount to the account of the participant, the employer will contribution a portion of the profits o Can be in cash or in stock (if stock this is called employee stock ownership plan) Cash Balance Plans Defined benefit plan in which benefits are based on contributions over the life of the plan No actual accounts, the account is just an “IOU” from employer More attractive to workers who switch from job to job The Management of Pension Funds- Most sponsors use trustee to invest contributions provided by the sponsor and pay benefits to retired participants Adv. To having plans managed by outside trustee o Lower transaction costs o Greater expertise and has equipment and personnel o Greater expertise with dealing with regulations o Enhances credibility of plan 10/7/2019 11
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Regulation of Pension Plans ERISA- o Employee Retirement income security act- page 281 Pension Insurance- o Pension Benefit Guarantee corporation- est. by ERISA. Insure defined
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  • Fall '19
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