Question

1.) Explain the difference between “defined-benefit” retirement plans and “defined-contribution” retirement plan. Which approach is better? Why?

2.) Discuss the various components of the National Social Security Program. Explain the extent of its coverage and it’s membership. Explain how it is financed, how it pays benefits to its members. What it’s solvency. Provide recommendations for long term sustainability.

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Answer 1

1.) Explain the difference between “defined-benefit” retirement plans and “defined-contribution” retirement plan. Which approach is better? Why?

The retirement plans divided into two categories of plans: Defined benefit pension plans and Defined contribution plans.

As the names suggest, a Defined benefit pension plan provides a specified payment amount in the retirement of the employee.

Whereas a Defined contribution plan allows employees and employers to contribute and invest funds over time to save for retirement.

These basic differences decide as to who, the employer or employee, bears the investment risks and affects the cost of administration for each plan.

Defined Contribution Plans

Defined contribution plans are funded primarily by the employee, called the participant, with the employer matching contributions to a specified amount.

A participant can decide to contribute a portion of his gross salary for the deduction to the plan, and the company matches accordingly. The contributions can be invested, at the participant's direction, in select mutual funds, money market or stock offered by the plan. As the employer no longer has any obligation on the account's performance after the funds are deposited, these plans require little work and are low risk to the employer. The employee must direct contributions and investments to grow the assets sufficient for his retirement.

Defined Benefit Plans

In this plan, Employers guarantee a specific retirement benefit amount for each participant of a defined benefit plan, which can be based on the employee's salary, years of service or a number of other factors. Employees have little control over the funds until they are received in retirement. The employer bears the investment risk of ensuring the defined benefit amount is able to be paid to the retired employee.

Due to this risk, defined benefit plans require critical financial projections and insurance for guarantees. This makes the costs of administration very high for the Employer.

Defined Benefit Plans define the benefit ahead of time: a monthly payment in retirement, based on the employee’s tenure and salary, for life. Usually, the funding expense accrues entirely to the company; employees are not expected to contribute to the plan, and they do not have individual accounts. Their right is not to an account, but to a stream of payments.

In Defined Contribution Plans, the benefit is not known, but the contribution is. It comes in a designated amount from the employee, who has a personal account within the plan and chooses investments for it. Since investment results are not predictable, the ultimate benefit at retirement is undefined. But the employee owns the account itself and can withdraw or transfer the fund, within plan rules.

2.) Discuss the various components of the National Social Security Program. Explain the extent of its coverage and it’s membership. Explain how it is financed, how it pays benefits to its members. What it’s solvency. Provide recommendations for long term sustainability.

Social Security system has three major components: retirement benefits, survivors' benefits and disability insurance. Social Security is an important part of the Old-Age, Survivors, and Disability Insurance program and run by the Social Security Administration.

Social Security's benefits include retirement income, disability income, Medicare and Medicaid, and death and survivorship benefits. Social security functions as a social security device (social safety net) for ensuring stable and anxiety-free lives in preparation against difficulties that might endanger the stability of living such as illness, injury, need for care, unemployment, retirement without means to earn money, and unforeseen accidents.

In short it is an Act to provide for the general welfare by establishing a system of old-age benefits, and by enabling the several states to make more adequate provision for aged persons, blind persons, dependent and crippled children, maternal and child welfare, public health, and the administration of their unemployment.

One who is 62 years of age and has worked consistently during his lifetime, is eligible to be a member of the national social security program.

While paying benefits to its members, the first step in the Social Security formula is determining your average indexed monthly earnings.  

To calculate your indexed monthly earnings, each year of earnings throughout your working lifetime is taken into account. Then, each year's earnings are adjusted for inflation, or "indexed."

The formula uses your 35 highest years of earnings. The calculation is done by adding all 35 years of indexed earnings together, dividing by 35 to find your annual average, and dividing this result by 12 to determine your lifetime monthly average.  

Solvency for the Social Security program is defined as the ability of the trust funds at any point in time to pay the full scheduled benefits in the law on a timely basis.

Social Security is financed through a dedicated payroll tax. Employers and employees each pay the specified percent of wages, while the self-employed pay a specified percent. ... This amount, called the earnings base, rises as average wages increase.