12/10/2012
1. Defined benefit plan
2. Defined contribution plan
1. Under a defined benefit plan, the employer agrees to give retirees a specific defined benefit, such as $500 per
month, 80 percent of his or her average salary over the 5 years preceding retirement, or 2.5 percent of his or her
highest salary for each year of employment.
3. Under a profit sharing plan, the employer makes payments into the retirement fund that vary with the level of
corporate profits.
4. The cash balance plan is a new type of retirement plan developed in the late 1990s. It is like a defined benefit
Chapter 29 Mini Case for Pension Plan Management
A. How important are pension funds to the U. S. Economy?
B. Define the following pension fund terms:
Southeast Tile Distributors Inc. is a building tile wholesaler that originated in Atlanta but is now considering expansion
throughout the region to take advantage of continued strong population growth. The company has been a “mom and pop”
operation supplemented by part-time workers, so it currently has no corporate retirement plan. However, the firm’s owner,
Andy Johnson, believes that it will be necessary to start a corporate pension plan to attract the quality employees needed to
make the expansion succeed. Andy has asked you, a recent business school graduate who has just joined the firm, to learn
all that you can about pension funds, and then prepare a briefing paper on the subject. To help you get started, he sketched
out the following questions:
Pension funds constitute the largest class of investors. In 2011, the funds had assets of over $17.9 trillion and they owned
45% IRA assets. Thus, pension funds are a major force in the financial markets.
5. An employee is vested if he or she has the right to receive pension benefits even if they leave the company prior
6. A portable pension plan is one that an employee can carry from one employer to another. Portability is
7. If the present value of expected retirement benefits is equal to plan assets on hand, the plan is said to be fully
funded. If assets exceed the present value of benefits, then the plan is overfunded, while the plan is underfunded if
the present value of benefits exceeds assets. If the plan is underfunded, an unfunded pension liability is said to
exist.
3. Profit sharing plan
4. Cash balance plan
5. Vesting
6. Portability
Defined benefit plans are more costly to firms when older workers are hired as opposed to younger workers,
2. The possibility of sex discrimination in hiring?
9. The Employee Retirement Income Security Act Of 1974 (ERISA) is the basic federal law governing the
10. The Pension Benefit Guarantee Corporation (PBGC) is a government-run insurance company created by the
ERISA to ensure that employees of companies which go bankrupt before their plans are fully funded will receive
benefits.
The defined benefit plan places most of the risks on the company, because it guarantees to pay a more or less
fixed retirement benefit regardless of its ability to fully fund the plan. Conversely, the defined contribution and
F. How does the type of pension plan influence decisions in each of the following areas:
1. The possibility of age discrimination in hiring?
C. What two organizations provide guidelines for reporting pension fund activities to stockholders? Describe
briefly how pension fund data are reported in a firm’s financial statements. (Hint: consider both defined
contribution and defined benefit plans.)
The Financial Accounting Standards Board (FASB), together with the SEC, establishes the rules under which a firm
D. Assume that an employee joins the firm at age 25, works for 40 years to age 65, and then retires. The employee
lives another 15 years, to age 80, and during retirement draws a pension of $20,000 at the end of each year. How
much must the firm contribute annually (at year-end) over the employee’s working life to fully fund the plan by
retirement age if the plan’s actuarial expected rate of return is 10% and its assumed interest rate for discounting
pension benefits also is 10%? Draw a graph which shows the value of the employee’s pension fund over time.
Why is real-world pension fund management much more complex than indicated in this illustration?
E. Discuss the risks to both the plan sponsor and plan beneficiaries under the four types of pension plans.
The employee will draw an annual pension (an annuity) of $20,000 for 15 years. Thus, the firm must accumulate
$152,121.59 in the pension plan by the time the employee retires to fully fund the retirement:
G. What are the two components of a plan’s funding strategy? What is the primary goal of a plan’s investment strategy?
Because of the increased number of retirees, and the dramatic escalation in health care costs over the past 10
4. The militancy of unions when a company faces financial adversity?
Since defined benefit plan benefits are usually tied to the number of years worked and the final (or last several)
year’s salary, unions are more likely to work with a firm to ensure its survival if it has a defined benefit plan.
The two components of a plan’s funding strategy are: (1) How fast should any unfunded liability be reduced? (2)
H. How can a corporate financial manager judge the performance of pension plan managers?
Pension fund assets are tapped when a company terminates an overfunded defined benefit plan, uses a portion of
J. What has happened to the cost of retiree health benefits over the last decade? How are retiree health benefits
reported to shareholders?
I. What is meant by “tapping” pension fund assets? Why is this action so controversial?
3. Employee training costs?