The Future of Pension Plans in the US Essay

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Pension Liability, Costs, Recognition, and Future Developments

In measuring the liability of pension plan, it requires discounting a stream of promised future benefits to the present. The plans that relate to the public sector the discount rate used in the calculation is subject to considerable debate. Plans for state and locals follow the general actuarial model and hence, liabilities are discounted by the yield of long-term assets held in the pension fund, which is roughly eight percent. For most economists, they contend the discount rate and say that it should reflect the risk associated with the liabilities, given the benefits are guaranteed under most state laws, the most appropriate factor of discount is a rate that is riskless, roughly 5%. Therefore, the model exhibited by the economists would produce much higher liabilities than those reported on books of localities and states. The debate is intensified and fueled by the assumption that the liabilities magnitude dictates the size of funding contribution and the way the funds of pension's assets should be invested. In this mini-paper, we attempt to separate the questions of liabilities valuing from the issues of investment and funding. The background will explain the current approach to liabilities valuing in both public and private sectors. The second issue of the paper will be discussing why state and local pension liabilities would be discounted at riskless rates. Thereby, shows the much-measured liabilities would increase by applying the rates stated. The third argument of the paper is that valuing liabilities is only a factor that enters the funding calculation. By using a riskless discount, it does not necessarily mean that the contributions increase immediately (Munnell et al., 1).

Importance of the topic

By considering valuing pension liabilities using the riskless rate is valid with the implication that such a change would probably affect the attitudes of taxpayers and government officials towards liberalizing plan provisions when retirement plans appear to be more than adequately funded. Hence, such a plan design avoids the type of benefits liberalization that occurred in the 1990s where many state and local programs appeared overfunded. For instance, the California Public Employees' Retirement System (CalPERS) reported assets as 128% of stated liabilities and the legislature of California were forced to enhance their benefits of both current and future employees. This reduced the age of retirement; benefits rates of accrual were increased, and the salary base for benefits was shortened towards the final year's salary. In such a case, if the liabilities of CalPERS had been valued at the riskless rate, then the overall percent funded would have been 88. Therefore, having an accurate accounting of liabilities increases the incentive for politicians to make the necessary changes in ages of retirements and other provisions of new employees to reflect the fact that the American population now lives longer and healthier lives (Munnell et al., 6).

The U.S. local and state economies have had a slow recovery period, workforce costs that include pension among other benefits and remain in the front-page news. As such, public officials and taxpayers want to know the size of their financial obligations to retirees and employees of retirement benefits in an attempt to assess how much it will cost them today and in the future to meet the stated commitments. When determining the obligations, it is straightforward due to the governmental accounting standards and excellent actuarial standards outlined in the accepted methods that measure pension liabilities. The most common method used is that of long-term assumptions and methods that include expected return rates on plan assets. The alternative measures have brought great deals of confusion and controversy and have resorted to using the applicability of market value of liabilities (MVL) to the public-sector pension obligations. For such a case, the market-based measures are explored and through this, an examination of the most fundamental public-sector decision makers are exhibited (Angelo 9).

As per the mission and vision stated by the FASB, they intend to improve and establish standards of financial accounting and to report that guides and educates the public and includes auditors, issuers and the everyday users of financial information. While fulfilling their mission, it is the responsibility of the Board to focus on the relevance and reliability of existing information dealing with their finances. Thereby, the data will enable them make proposed improvements to the information and strive to achieve comparability and consistency in accounting for transactions that are similar. The cost-benefit for such assessments reflect on the judgment of standards setter, and the mission statement of FASB looks at striving to determine proposed rules fill a significant need and imposed costs as compared to other possible alternatives.

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A pension is considered as a cash payment made to retired employees. In talking about the pension rights, it means they are accrued by their employees as they work, and it is all based on the employer's pension plan. The two types of pension schemes available are the defined contribution and defined benefits plans. The defined contribution plans are the contribution plans a company invests its contributions on behalf of the employee's years of working. In normal circumstances, both the employer and employee contribute to the scheme. However, the pension of the employee all depends on the total contributions and the investment returns earned on the contributions. An example of this plan is the 410k plan and in this plan, the employees contribute a portion of their gross pay to the investment of the mutual funds. The advantage of the 410k plan are that the contributions of the employee are deducted from taxes and the contributions, and earnings-related are not taxed until they are withdrawn at retirement. Moreover, in most cases, some portions of the contributions made by the employee are matched by the employee. By doing this, the costs raised by the employer are then debited to the Pension Expense (Warren, Reeve and Duchac 518).

As for the expense benefits plans, this is where the company pays the employee fixed annual pension based on a given formula. The basis of the method is on factors such as the employee's years of service, past salary, and age. In this scheme, the employer is obligated to pay for the employee's future pension benefits and many companies; they are replacing their defined benefits plans with the contribution programs. The transaction of this plan is a debit to the Pension Expense. The employer will then credit the cash for this transaction for the contribution made. For any of the unfunded amount, credit is made to the Unfunded Pension Liability and if it is to be paid within one year, then on the balance sheet it is reported as a current liability. Those made beyond one year are termed as long-term liabilities (Warren, Reeve and Duchac 519).

Topic Relation to Financial Accounting

The question above relates to the aspect of actuarial assumptions as they are concerned with pension funding and accounting that require assumptions to be made about the future. These actuarial assumptions are used by pension accountants and corporations to project future benefits and all these is approved by external auditors of the company in their general auditing of financial statements of the enterprise. The two types of assumptions that are in question are economic and demographic assumptions. The economic assumption deals with the current interest rates, market, investment, and salary increases. The question that arises in this assumption is how the market forces affect the cost of the plan. The demographic assumption is all about the participant group make-up and their expected behavior and expectancy of life. The question arising is how the participant behavior affects the cost plan. The current practices measuring pension liabilities of the public pension plans are seen to provide information plans to stakeholders and decision makers about the much it will cost to satisfy their financial obligations to their employees or participants over time. The accomplishment of such a move is by calculating the actuarial accrued liability (AAL) that gives basis to current information and reasonable expectation of future events.

Analysis

Fundamentally, having a retirement plan is beneficial for the individuals, business and employees and they allow one to invests for the financial security when an employee retires. As a bonus, the employer and employee get significant tax advantages among other incentives. The benefits of the retirement plan for the business include tax-deductible contributions, assets owned through the plan grow and become tax-free, and available and flexible plan options. Besides, they plan and retain better employees thus reducing new costs incurred in employee training and the tax credits among other incentives for starting the retirement plan may reduce costs incurred. For the employee, the benefits include reduced current taxable income, gained contributions and investments are not taxed until they are distributed; contributions are easy to make through payroll deductions. Besides, the interest compounded over time allows small regular contributions to grow significantly into retirement savings and assets of retirement can be carried from one employer to another. Lastly, saver's credit is available, and the….....

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