Defined Benefit Pension Plans

Employees often prefer Defined Benefit pension plans over Defined Contribution because risks are transferred to their employers.

  • Pension Adjustment = 9 x Pension Entitlement - $600
  • employees know precisely their contributions and pension benefits
  • employer bears investment risk à doesn’t know its costs
  • contributions determined by an actuary and adjusted (e.g., every three years)
  • types:
    • flat benefit
    • career average earnings
    • final average earnings
    • best earnings

Maximum yearly pension = min{$2,000 (2005) per year of pensionable service (YOPS), 2% × YOPS × avg of best 3 consecutive years of earnings}

The maximum yearly pension is the minimum of

  1. $2,000 (in 2005) per year of pensionable service (YOPS), and
  2. 2% × YOPS × avg of best 3 consecutive years of earnings
  • employees know the exact amount of their own contributions and their plan benefits
  • employers don't know the amount of their contributions since the capital needed depends upon investment returns during the accumulation phase
    • large potential liability for employer since the employer must provide adequate funding for the promised future benefits
  • upon retirement, funds can
    • buy a life annuity
    • be transferred to a LIRA or LIF
  • four formulas for determining benefits
    1. best earnings
    2. final average earnings
    3. career average earnings
    4. flat benefit
  • past service benefits may be available for service with employer before the pension plan was implemented
    • employer funded only → reduced benefit ( e.g., 1% per year of pensionable service versus 2%)

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