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If a plan is not well-funded, the plan sponsor may not have the financial resources to continue funding the plan.

University of California Retirement Plan (UCRP)

Traditional defined benefit plan designs because of their typically flat accrual rate and the decreasing time for interest discounting as people get closer to retirement age tend to exhibit a J-shaped accrual pattern of benefits, where the present value of benefits grows quite slowly early in an employee's career and accelerates significantly in mid-career: in other words it costs more to fund the pension for older employees than for younger ones an "age bias". Defined benefit pensions tend to be less portable than defined contribution plans, even if the plan allows a lump sum cash benefit at termination.

Most plans, however, pay their benefits as an annuity, so retirees do not bear the risk of low investment returns on contributions or of outliving their retirement income. The open-ended nature of these risks to the employer is the reason given by many employers for switching from defined benefit to defined contribution plans over recent years.

The risks to the employer can sometimes be mitigated by discretionary elements in the benefit structure, for instance in the rate of increase granted on accrued pensions, both before and after retirement. The age bias, reduced portability and open ended risk make defined benefit plans better suited to large employers with less mobile workforces, such as the public sector which has open-ended support from taxpayers.

This coupled with a lack of foresight on the employers part means a large proportion of the workforce are kept in the dark over future investment schemes.

Defined benefit plans are sometimes criticized as being paternalistic as they enable employers or plan trustees to make decisions about the type of benefits and family structures and lifestyles of their employees. However they are typically more valuable than defined contribution plans in most circumstances and for most employees mainly because the employer tends to pay higher contributions than under defined contribution plans , so such criticism is rarely harsh.

The "cost" of a defined benefit plan is not easily calculated, and requires an actuary or actuarial software. However, even with the best of tools, the cost of a defined benefit plan will always be an estimate based on economic and financial assumptions. These assumptions include the average retirement age and lifespan of the employees, the returns to be earned by the pension plan's investments and any additional taxes or levies, such as those required by the Pension Benefit Guaranty Corporation in the U.

So, for this arrangement, the benefit is relatively secure but the contribution is uncertain even when estimated by a professional. This has serious cost considerations and risks for the employer offering a pension plan. One of the growing concerns with defined benefit plans is that the level of future obligations will outpace the value of assets held by the plan. This "underfunding" dilemma can be faced by any type of defined benefit plan, private or public, but it is most acute in governmental and other public plans where political pressures and less rigorous accounting standards can result in excessive commitments to employees and retirees, but inadequate contributions.

Many states and municipalities across the United States of America and Canada now face chronic pension crises.

Many countries offer state-sponsored retirement benefits, beyond those provided by employers, which are funded by payroll or other taxes. In the United States, the Social Security system is similar in function to a defined benefit pension arrangement, albeit one that is constructed differently from a pension offered by a private employer; however, Social Security is distinct in that there is no legally guaranteed level of benefits derived from the amount paid into the program. Individuals that have worked in the UK and have paid certain levels of national insurance deductions can expect an income from the state pension scheme after their normal retirement.

The state pension is currently divided into two parts: the basic state pension, State Second [tier] Pension scheme called S2P. Individuals will qualify for the basic state pension if they have completed sufficient years contribution to their national insurance record. The S2P pension scheme is earnings related and depends on earnings in each year as to how much an individual can expect to receive.

It is possible for an individual to forgo the S2P payment from the state, in lieu of a payment made to an appropriate pension scheme of their choice, during their working life. For more details see UK pension provision. In a defined contribution plan, contributions are paid into an individual account for each member. The contributions are invested, for example in the stock market, and the returns on the investment which may be positive or negative are credited to the individual's account. On retirement, the member's account is used to provide retirement benefits, sometimes through the purchase of an annuity which then provides a regular income.

Defined contribution plans have become widespread all over the world in recent years, and are now the dominant form of plan in the private sector in many countries. For example, the number of defined benefit plans in the US has been steadily declining, as more and more employers see pension contributions as a large expense avoidable by disbanding the defined benefit plan and instead offering a defined contribution plan.

Money contributed can either be from employee salary deferral or from employer contributions. The portability of defined contribution pensions is legally no different from the portability of defined benefit plans.

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However, because of the cost of administration and ease of determining the plan sponsor's liability for defined contribution plans you do not need to pay an actuary to calculate the lump sum equivalent that you do for defined benefit plans in practice, defined contribution plans have become generally portable. In the United Kingdom, for instance, it is a legal requirement to use the bulk of the fund to purchase an annuity. The "cost" of a defined contribution plan is readily calculated, but the benefit from a defined contribution plan depends upon the account balance at the time an employee is looking to use the assets.

So, for this arrangement, the contribution is known but the benefit is unknown until calculated. Despite the fact that the participant in a defined contribution plan typically has control over investment decisions, the plan sponsor retains a significant degree of fiduciary responsibility over investment of plan assets, including the selection of investment options and administrative providers.

A defined contribution plan typically involves a number of service providers, including in many cases:. In the United States, the legal definition of a defined contribution plan is a plan providing for an individual account for each participant, and for benefits based solely on the amount contributed to the account, plus or minus income, gains, expenses and losses allocated to the account see 26 U.


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Examples of defined contribution plans in the United States include individual retirement accounts IRAs and k plans. In such plans, the employee is responsible, to one degree or another, for selecting the types of investments toward which the funds in the retirement plan are allocated. This may range from choosing one of a small number of pre-determined mutual funds to selecting individual stocks or other securities.

Most self-directed retirement plans are characterized by certain tax advantages , and some provide for a portion of the employee's contributions to be matched by the employer. In exchange, the funds in such plans may not be withdrawn by the investor prior to reaching a certain age—typically the year the employee reaches In the US, defined contribution plans are subject to IRS limits on how much can be contributed, known as the section limit.

These numbers usually increase each year and are indexed to compensate for the effects of inflation. Hybrid plan designs combine the features of defined benefit and defined contribution plan designs. A cash balance plan is a defined benefit plan made to appear as if it were a defined contribution plan. They have notional balances in hypothetical accounts where, typically, each year the plan administrator will contribute an amount equal to a certain percentage of each participant's salary; a second contribution, called interest credit , is made as well.

These are not actual contributions and further discussion is beyond the scope of this entry suffice it to say that there is currently much controversy. In general, they are usually treated as defined benefit plans for tax, accounting and regulatory purposes. As with defined benefit plans, investment risk in hybrid designs is largely borne by the plan sponsor.


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  5. As with defined contribution designs, plan benefits are expressed in the terms of a notional account balance, and are usually paid as cash balances upon termination of employment. These features make them more portable than traditional defined benefit plans and perhaps more attractive to a more highly mobile workforce. Target benefit plans are defined contribution plans made to match or resemble defined benefit plans.

    Advocates of defined contribution plans point out that each employee has the ability to tailor the investment portfolio to his or her individual needs and financial situation, including the choice of how much to contribute, if anything at all. However, others state that these apparent advantages could also hinder some workers who might not possess the financial savvy to choose the correct investment vehicles or have the discipline to voluntarily contribute money to retirement accounts. This debate parallels the discussion currently going on in the U.

    Defined contribution pensions, by definition, are funded, as the "guarantee" made to employees is that specified defined contributions will be made during an individual's working life.


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    There are many ways to finance a pension and save for retirement. Pension plans can be set up by an employer, matching a monetary contribution each month, by the state or personally through a pension scheme with a financial institution, such as a bank or brokerage firm.

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    Pension plans often come with a tax break depending on the country and plan type. This plan allows contributions to this account to be marked as un-taxable income and remain un-taxed until withdrawal. Most countries' governments will provide advice on pension schemes. The concept of a pension appeared in the 7th-century Rashidun Caliphate as a form of Zakat charity , one of the Five Pillars of Islam , under early Islamic law.

    This practice continued well into the Abbasid Caliphate 8thth centuries. The taxes collected in the treasury of an Islamic government were used to provide income for the needy, which were classified as the poor, elderly, orphans, widows, and the disabled. Widows' funds were among the first pension type arrangement to appear. For example, Duke Ernest the Pious of Gotha in Germany founded a widows' fund for clergy in and another for teachers in It is sometimes claimed that at the time life expectancy for the average Prussian was 45 years; in fact this figure is due to the very high infant mortality and high maternal death rate from childbirth of this era.

    In fact, an adult entering into insurance under the scheme would on average live to 70 years of age, a figure used in the actuarial assumptions included in the legislation. There is a history of pensions in Ireland that can be traced back to Brehon Law imposing a legal responsibility on the kin group to take care of its members who were aged, blind, deaf, sick or insane.

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    In , there were over 76, pension schemes operating in Ireland. Today the Republic of Ireland has a two-tiered approach to the provision of pensions or retirement benefits. First, there is a state social welfare retirement pension, which promises a basic level of pension.