Defined Benefit Pension Plans

Definition of the Topic. According to Purcell, the concept of the defined benefit pension plans is referred to as a retirement plan that is sponsored by an employer, according to which the benefits of employees are calculated based on the already established formula, making the use of factors such as the employment duration, as well as the salary history (Purcell 1). In addition, these benefit pension plans usually are in different forms. In accordance with this plan, the employer is the one who bears the risk that assets might at times fail to produce the adequate investment returns, which can support the target retirement benefits’ level. Besides, employees accept the risk, since the investment outcome might fail to produce an expected level of the retirement income; and this is often witnessed in cases whereby the yields realized are lower than the anticipated ones. In essence, the defined benefit pension plans are often structured in different ways to meet the intended goals of building high performance organizations. It is important to understand the basic packages, compensation programs, and structures so that a company would be able to effectively lay strategies and plans necessary in helping to incentivize employers so as to achieve the goals of the company. The compensation program that is well designed and implemented would not only benefit pensionable employees, but could also increase the company’s profits (Cannon and Tonks 1).

Under the defined benefit pension plan arrangement, the employers commit to paying specific sum of money on behalf of their employees for the specific benefits for the entire life commencing at the workers’ retirement. This sum of money contributed for the employees’ benefits is made known to them in advance, and it is pegged on factors such years worked, earnings, and age. The defined benefit pension plans do not usually have specific limits of contributions. However, under the defined benefit pension plans arrangements, “the employer is charged with the responsibility of making crucial decision on the amount of money to contribute towards this scheme and how to invest the contributed sum of money” (Cannon and Tonks 1). Therefore, the employers’ contributions towards this plan are pegged on the benefit formula, which is used for calculating the investments required so as to meet this defined benefit. The contributions towards the defined benefit pension plans are defined by actuaries, who use statistical analysis tools for calculating the costs associated with future risks. These calculations under the defined benefit pension plans put into account the life expectancy of the employee, interest rates changes, retirement age, the amount of retirement benefit per year, and possibly the employee’s turnover (Purcell 1).

Background and History

In the United States, the first benefit plans were regarded to have been sponsored by the US military as well as the colonial militias, who were behind the country’s independence. The benefit pension plans in America date back to 125 years. For example, the first company to introduce a private benefit pension plan in 1875 was dealing with railroad freight forwarding. The company introduced the benefit pension plan that was in order to make sure there would be the stability in the workforce, an idea that had been promoted as the part of its strategic goals. This company’s strategic plan was later on followed by other railroad companies in America; and the introduction of benefit pension plans was really gaining a lot of momentum at the moment (Kawachi, Karen and Toder 2).

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In the first twenty years of the twentieth century, some of the largest employers in the United States began following the steps taken by railroads in introducing pension plans. For example, the company was not left behind in this noble venture, and it introduced its benefit pension program to incentivize its employees in 1906 (Purcell 1). In fact, by the end of 1920, benefit pension plans had become the famous contractual employment dealing between employees and large employers.

Pension plans made the remarkable achievements between 1930s and 1940s to be what they are currently recognized internally. Such economic events in the global history as the Great Depression had significant impacts on the private benefit pension plans. This led to the failure of the plans’ operation among many corporate ventures. However, the government was quick to react to these disastrous economic conditions of the depression by raising tax rates, especially among those people classified as the highest income earners in the United States. As a result, corporations that contributed to these schemes of benefit pension plans enjoyed certain tax benefits. Moreover, the social security adoption made it possible to reduce the high benefits demand from labour, thus, making modest benefits payments easier. Consequently, the numbers of benefit pension plans were on the rise, especially among some smaller employers.

As a result of the legislative foundation that was put in place during the times of the Great Economic Depression, it was witnessed that the number of the private workforce that took part in the pension plans rose significantly in 1945 and 1970, thus, increasing from 19 percent to 45 percent. It was witnessed that many pensions programs had become institutionalized during these times, and the various publicized failures took place. These failures led to the increased legislation on pension plans during the entire period, and this resulted into the adoption of the ERISA in1974, that is the Employee Retirement Income Security Act (“Congressional Budget Office” 1).

Indeed, the history behind the establishment of the defined pension contribution plans can be regarded as recent. Before 1978, several companies were engaged into offering some profit-sharing plans and some other compensation plans to their employees, and the employees had a choice of deferring a part of the non-salaried compensation, thus, directing it into this plan. In 1981, another remarkable plan was witnessed in the history when the company successfully designed the initial 401(k) plan that allowed the employees to make a choice to defer a part of their personal salary pretax. Few months later, after the initial salary reduction under the 401(k) programs, the IRS, that is the International Revenue Service, issued a proposal that had been barring the use of the employees’ salary reductions as sources of revenue contributions for these plans. Many companies that already had the existing deferred compensation programs sought the approval of the approval of the IRS, and turned their defined contribution programs into the credible and tax-advantaged retirement plans (Kawachi, Karen and Toder 1).

The popularity of these 401(k) plans had grown rapidly over the next two decades. This popularity was owing to the increased costs and liability associated with the defined benefit pension plans, and the employers were really finding it hard to cope up with such high expenditures of operating those plans. In essence, most firms that were operating under the defined benefit plans’ arrangements found it cheaper to adopt the 401(k) plans as a supplement to the defined benefit pension plans; and their new employees were offered the 401(k) plans to be the main retirement savings program (Orszag 1). On the other hand, many new firms that had not already adopted the defined benefit plans chose to adopt the 401(k) plans for their employees as the main retirement savings program. However, currently the situation of the defined benefit plans has changed significantly over the past three decades.

Between 1985 and 2002, the amount of the retirement assets in the US increased significantly from USD 2.4 trillion to about USD 10 trillion. This significant increase in America’s savings was attributed to the strong economy coupled with the market growth as well as the increasing income demand for the baby-boomer generation that was approaching the retirement age during that period. In addition, it was realized during this period that the Gross Domestic Product (GDP) rose from 67 percent to 95 percent in 2002 (Orszag 2). Though, the assets of the retirement savings plans increased significantly over this period of 17 years that of the defined benefit plans have almost increased twofold (Flannery 46).

Relevance of the Topic to Wage and Salary Administration. The concept of defined benefit pension plans is relevant to the wage and salary administration in the sense that its contributions are pegged on some individual’s personal earning deductions. A part of the contribution to this plan is paid by the employer on behalf of the employee, and this depends on a fixed percentage that is determined by the employer. The defined benefit pension plans’ arrangements guarantee the employees a specific payout when they reach the age of retirement. The amount to be paid to retirees is based on a fixed formula, and this often depends on the employee’s salary as well as the number of years taken to be a member of the defined benefit pension plan (Purcell 2). The amount paid for the retirement does not depend only on the total sum of money contributed, but also according to the performance of the investment portfolio that was used.

Application of the Topic

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Examples of Companies Utilizing This Program.

One of the companies that utilize defined benefit pension plans is the American Express Company. This company sponsors this program on behalf of its workers. The following table shows total costs related to defined benefit pension plans, which the company incurred in a period of three years.

The American Express Company (AXP) carried out some amendments on the retirement plan in January 2007, as well as the supplemental Retirement Plan (SRP) was put in the operation in the beginning of July 2007 (Purcell 2). The latter provided that the active members of the scheme were meant to immediately vest in some of their accrued benefits, but they were not supposed to accrue any benefit in the future, apart from the interest credits. Consequently, this led to the fall in the expected benefits of $91 million, against the actual gain realized of $63 million (“Congressional Budget Office” 1). This prompted the American Express Company to make some modifications to this program in the US so as to create the greater contributions.

Moreover, the other company under the defined benefit pension plans is the Johnson Insurance & Financial Company that operates in Texas and has been operating the program for nearly three years. Part of its $500, 000 annual revenue is directed towards the savings for the retirement plan. 10% of its net revenue is directed towards the program, and 35% is paid for the tax bill (Taylor 1).  Three years ago they made a lot of savings since only $200,000 was paid towards the defined benefit pension plans. The managers of Jonson Insurance & Financial Company use the actuarial formula to calculate the employees’ contributions to the program, and this has proved to be more accurate over the years (“BLS Information” 1).

Positive and Negative Effects of the Program. There are a number of benefits associated with these programs because the employees are given the opportunity and encouraged to save for their retirement. The amount of the money deducted from the employees’ salary is often fixed, therefore, it is easy to plan and manage. Under these programs, the employer makes a certain contribution towards the employee’s savings. This acts as an incentive and motivation to employees, thus, they are encouraged to work hard and improve their productivity. However, the negative effects of these programs are witnessed when the company is burned with a lot of costs, in the form of contributions towards these plans. The employers do not share the benefits of this program, thus, the company’s costs cannot be compensated under these programs, a situation that adversely affects the profitability of the company. In addition, these programs are not easy to design and implement, thus, the company’s resources might be overused in rolling out such programs (Orszag 1).

Regulations, Ethics and Social Responsibility

There are the certain aspects of this topic that are covered by the United States regulation. This is witnessed the legal proposal made in the department of labor with the aim of reforming the act on the Federal Employees Compensation(“BLS Information” 1). This amendment has been carried out to facilitate the improvements on return-to-work incentives, promote the corporate social responsibility, enhance the equity in the benefit structure, promote the ethical integrity of the program, and create more employment opportunities for the individuals with disabilities. Other aspects that are covered in the US regulation are more incentives to encourage workers, safe and favorable working conditions, modernized benefits for those at their retirement age. Moreover, these would enhance the program management and integrity.

Some ethical issues of this topic would include the lack of established incentive schemes for employees, denying employees the chance to become the members of defined benefit pension plans, and the failure in the part of the employers to deduct the part of the employees’ salary that is supposed to be submitted to these programs. Indeed, some issues are considered ethical, while others are not. For example, if a payroll administrator deducts the part of the employee’s salary, but fails to remit it to the scheme, then it is unethical (Flannery 68). On the other hand, it is ethical for the employer to contribute towards the defined benefit pension plans on behalf of the employees.

Once a company has a social responsibility as a priority, it can apply this information apportioning the part of its revenue earnings towards helping the community. For example, 2% of its earnings can be channeled towards helping the orphans and elderly people in the community. This money is accounted for as the expenditure in the financial management reports. The money can as well be put in some investment vehicles to earn the returns/interest so as to widespread the corporate social responsibilities undertaken by the company, such as building dams and planting trees for the benefit of the community. As a result, the company will also benefit by attracting many clients (Flannery 72).

Recommendations to Management

Based on what has been learnt from this topic, I would recommend to management to implement a good compensation program that would incentivize the employees; for instance, creating benefit pension plans, whereby the employers contributes a fixed percentage of the company’s revenue on behalf of the employees. Therefore, fund managers should make sure that the contributions made towards these programs are invested in the right projects that would give the highest returns to participants. This would involve the implementation of bonus incentive programs, which are based on the performance. In addition, the managers would come up with defined benefit pension plans to encourage savings for the retirement. Policies on equitable salaries and wages should also be implemented. The managers can as well implement policies for the compensation on accident cases, and even those regarding contributions towards the burial expenses as well as hospital bills.

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Importantly, the company should take various steps to ensure that the desired results are achieved with the implemented compensation program such as putting the contributions in the right investment vehicle to generate good returns to members. Making sure that the compensation program is based on the performance and productivity. Finally, the cost of implementing the program must be calculated against the expected benefits, that is, the company should carry out the cost-benefit analysis to determine the worth and viability of the project. Finally, it is important for the company to engage into the corporate social responsibility as well.

However, the managers should not engage in unethical practices that would not motivate the employees and spoil the good reputation of the company, since these unethical practices could lock out potential investors and customers. Besides, the managers should not implement very expensive programs the costs of which outweigh the benefits realized.

Results of Recommendations

If the company has implemented the recommendations, it would realize the increased productivity and growth. The employees would be motivated to work hard to ensure the maximum output due to the incentive program. On the other hand, many customers would be attracted to the company due to its success and the corporate social responsibility program.

Concluding Statement

In conclusion, this topic is important since it ensures the success and growth among both the employees and the company. The employees benefit from the compensation programs, attractive wages and salary, and from the defined benefit pension plans that are well managed by fund managers. On the other hand, the company realizes more revenues in terms of the increased profitability due to the high productivity and the increased sale revenue. These benefits associated with successful programs are very essential for the continuity of the company.

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