Types of Pension Plans

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Western University
Actuarial Science
Actuarial Science 2427A/B
Kopp/ Davies

Types of Pension Plans • Not long ago, pension plans targeted a total retirement income (including all gov’t sources) of about 50% of an ee’s earnings at retirement. • Today, the level of income replacement believed needed is closer to 70% (over 80% for people with low incomes prior to retirement) • There are different types of pension plans (A) Defined Contribution Plans This type of plan defines the amount of contributions to be made by the er (and ee if the plan is contributory) • ee will be given several choices as to where to invest the contributions • the pension income amount is not guaranteed; it will not be known until the actual retirement date • it will depend on the amount accumulated in the ee’s account, and this depends on: 1. Investment returns 2. Age you retire 3. Years of service • As a result, in DC plans, it is the employee who has the investment risk • About 38.5% of all RPP’s are DC plans, but they cover only about 15.6% of all members (B) Defined Benefit Plans About 59.5% of all RPP’s are DB plans, covering about 79.6% of all plan members This type of plan defines the formula for the determination of the retirement benefit • ee’s are promised a “defined” amount of annual pension The cost of the plan to the er is the total amount of money required to provide the given level of benefit for all ees in the plan • this is determined using an actuarial basis and an actuary is needed to calculate this cost annually • contributory plans specify the % that ees must contribute to plan • er contributes the difference between cost of providing the benefits and the level of ee contributions • in some years this difference can be negative (due to several years of really good investment returns); for these years, the er can take a “contribution holiday” and pay $0 to the RPP As a result, in DB plans it is the employer who takes the investment risk Four Most Common DB Plans 1. Flat Benefit Annual pension is a specified number of dollars for each year of service Advantage Very simple; easy to understand by ees; good plan for low income ees Disadvantage The flat amount per year of service is based on wage levels at time the level is established, but pension will be paid in future when wages/prices have increased As a result, most flat benefit plans are subject to periodic upgrades to reflect increases in inflation and wages 2. Career Average Earnings Annual pension benefit is calculated as a certain percentage of earnings in each year of plan membership Advantage Easy and simple to understand Disadvantage • gives equal weight to employment earnings in each year of an ee’s working lifetime • this is ok if ee has neve
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