Pension Plans

Topics: Pension, Investment, Cash balance plan Pages: 13 (2060 words) Published: February 1, 2015

M07EFA Institutional investments

Course Leader: Karen McGrath
Word Count: 1820

Student’s Name:

LI XIAO LIN 5453418

Topic 5

The rapid growth of the pension schemes has a dramatic institutional effect on national labor and financial markets in past several decades and this upward trend will probably continue in the future. So we will embark on a study of pension plans.

Enterprise annuity plan is a system that according to enterprise’s economic strength and conditions established, aiming to secure staff retirement income and beyond the basic old-age insurance system for the government enforce. Enterprise pension funds is an important supplement of basic endowment insurance system, its direct purpose is improve the level of pension to retired workers. Enterprise annuity plan is generally regard as an important part of human resource management strategy, because it is able to attract and retain employees who long-term serve for enterprise and improve labor productivity through providing them with a retirement pension funds. According to the accumulation of pension funds and the difference of payment methods, pension scheme could be divided into two types; one is defined benefit and another is defined contribution.

The essay will introduce definition of the two pension plans at first, and then distinguish between two different pension types from different perspectives, and thus analyze their advantages and disadvantages. Finally, explain why DC plans has became increasingly important in corporate pension plans. Taking the 401(k) project for example to analyze the reason for its success.


Under a defined benefit (DB) plan the staff’s pension benefit premium is determined by a formula, which based on length of employment and salary or wages in most situations. That is to say, the DB mode provides participants or beneficiaries with a certain quantity of pension in every month since they retired and this pension amount are predetermined (Mary Stone, 1987). DB plans generally do not require the employees to pay and do not set up a private account. The common practice is employer pay the pension funds contributions monthly with the method of pay-as-you-go. However, with the development of defined benefit plans, some economists have put forward more effective approaches. According to the discussion of Merton, Bodie and Marcus (1987). Most of defined benefit formulas also take consideration of the Social Security entitlement in the schemes. This is a so-called integrated plan.

Defined Contribution (DC) schemes refer to employees and employers make regular contributions to pensions plans in private account. In other words, in the DC mode, how many contributions they paid for the pensions plan is fixed until the retirement date, but the sum of retirement pensions that beneficiary could receive is indefinite. Because benefit levels rely on the sum of all the past contributions and cumulative investment profits in the account, but investment returns are uncertain and employees need to take their own risks. Often employers pay the amount equal to a fixed percentage of wages monthly, or employer offer Matching Contributions based on the contributions of individual accounts. On the other hand, Employees possess investment decisions on their personal assets in pensions account and there are many investment types and products allow employees to choose to accumulate their pension funds. Additionally, many national laws and regulations have a tax preference policy for defined contribution. Such as tax deferred. That means employees can actually use tax-deferred retirement accounts to invest to increase the retirement funds.

In the DB scheme, annuity payment amount is uncertain and manager make a commitment to staff ensure that they can receive a pension after retirement in accordance with...
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