Question

Why, if you were a state government employee, would you prefer to participate in a defined benefit or a defined contribution pension plan? Explain the difference between the two types of plans in your answer

Answer 1

A defined contribution pension plan requires majorly an employee to put his own money into retirement account whereas a defined benefit contribution plan requires an employer to put money into retirement account of employees. The amount accumulated under defined benefit contribution plan is generally paid out in the form of regular payments over the lifetime of an employee beginning upon retirement while in defined contribution pension plan the contribution is invested as per participants’ (generally employee) directions and the accumulated fund is withdrawn as per his own choice.

2) Under a defined benefit contribution plan, Pension Expense equals to the amount contributed to the pension fund. The below formula is used to determine the pension expense each year:

Interest Cost (the increase in Projected Benefit Obligation because time passes)

Add: Service Cost (the increase in Projected Benefit Obligation because employees work an additional year)

Less: Expected Return on Pension Investments

Add/Less: Amortization of Actuarial and Performance Gains and Losses

Net Pension Expense

3) The balance in the Pension Asset/Liability account represents the difference between the Projected Benefits Obligation and the Plan Assets (the funded status). A Pension Liability is required when the Projected Benefits Obligation is more than the Plan Assets whereas a Pension Asset is required when the Plan Assets are greater than the Projected Benefits Obligation.