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The Basics of Pension Plans Regulated by ERISA

Pensions Liabilities and FundingHow is a defined benefit pension plan accounted for in company financial statements?
How is a defined benefit pension plan funded?
What is the PBGC?
Why do employee pension plans receive deferred tax treatment? 

Q:  How is a defined benefit pension plan accounted for in company financial
statements?
 

A:  The Financial Accounting Standards Board (FASB) Statements 87 and 88, issued in 1985, set forth the generally accepted accounting principals for pension plan financial reporting. The FASB statements define the measures used in plan sponsors' financial statements to express the cost of their defined benefit plans and the degree to which the plans are funded.   Within the standards set forth in the FASB statements, plan sponsors set the discount rate, long term rate of return on assets, and rate of salary increase used to calculate these costs.  The net periodic pension cost is the amount recognized in an employer's financial statements as the cost of the pension plan for a period (such as a year). This cost consists of service cost, interest cost, expected return on plan assets, amortization of gain or loss, amortization of unrecognized prior service cost and amortization of the unrecognized net obligation or asset existing at the date of initial application of FAS 87.

 The Accumulated Benefit Obligation, or ABO, approximates the plan's present liability. The projected benefit obligation (PBO) adds to the ABO future increases in compensation. The ratios of ABO and of PBO to the market value of assets are measures of the funded status of a company's plans.   The net impact of overfunding (asset) or underfunding (liability) is reported on the company's balance sheet; the total market value of assets is reported in the pension footnote to the financial statements. 

The accounting cost of the plan calculated according to FASB Standards generally differs from the funding requirement calculated using IRS provisions for cash funding, described below.

Q:  How is a defined benefit pension plan funded? 

A:  ERISA and the Internal Revenue Code set forth minimum and maximum funding standards for defined benefit plans to help assure that sufficient money will be available in each pension fund to pay benefits to plan participants when they retire.  For private trusteed plans, the plan sponsor obtains an annual actuarial valuation of the plan, which determines whether IRS standards require a cash contribution.  The level of minimum required contributions and maximum tax deductible contributions are a function of the funded status of the plan.  Based on the actuary's findings, the employer makes periodic cash contributions to a trustee, typically a bank or trust company, which are then invested in accordance with a trust agreement.

For private insured plans, the employer pays premiums to an insurance company, which agrees to provide specific benefits to plan participants when they retire.

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Q:  What is the PBGC? 

A:  ERISA established the Pension Benefit Guaranty Corporation (PBGC) to protect certain pension benefits in the event an uninsured defined benefit pension plan is not sufficiently funded to pay the benefits that are or will be due.

The PBGC's financial responsibilities are met through the payment of premiums assessed against the employers who provide uninsured defined benefit plans.  Premiums paid to the PBGC during 1999 were $902 million;  PBGC payments to retirees or their beneficiaries in 1999 totaled $901 million.

Q:  Why do employee pension plans receive deferred tax treatment? 

A:  Congress grants income tax advantages to pension funds in order to encourage savings and to provide security for retirement.

Subject to ERISA and Internal Revenue Code requirements and limitations, employers' contributions to qualified pension plans, and participants' contributions in some types of plans, are deductible from current income for the purpose of computing taxable income.  For the plans themselves, most investment earnings are not subject to current income tax.

However, for pension plans which qualify for this favorable tax treatment, plan participants and their  beneficiaries must include all payments from qualified pension plans in their taxable income at the time they receive the payments.  CIEBA estimates that among its members, the reduction in federal tax revenues resulting from deferral of contributions is offset by taxes paid by individuals on their distributions.  The tax on the contributions and earnings has therefore been deferred to the future rather than eliminated.  This policy of deferring taxes on savings for retirement has contributed to the growth of a retirement savings pool estimated at $12.3 trillion as of the end of 1999.  In addition to securing benefits and protecting the PBGC from ruinous claims in the event of a major recession or the decline of an industry, the pension system (including both private and public sector retirement plans) provides the single largest source of institutionalized savings in the United States and represents a growing and dependable source of capital for investment in the economy.

 

bulletTable of Contents 

bulletPensions Liabilities and Funding 

bulletIntroduction 

bulletRegulation of Defined Benefit Plans 

bulletThe Basics of Defined Benefit
    
Plans 

bulletInvestment of Defined Benefit Plan Assets 

bulletTypes of Pension Plans 

 

 

 

 

 

 

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