What is an employer pension plan?

An employer pension plan is a retirement benefit provided by an employer to employees before or after they retire. Over the course of the employees' working lives, the employer should invest a lump sum or make monthly contributions to investment schemes in employees' names. It is the employer's legal responsibility to provide employees with retirement plans that support them with guaranteed financial security in retirement.

Types of employer pension plans

Employer pension plans are used by a variety of private and public organizations to make retirement payments to their employees. Employees of a single employer are eligible for benefits under single-employer pension plans. Multiple employer plans, on the other hand, provide benefits to employees of multiple employers. Employers' pension plans are divided into two types: defined benefit plans and defined contribution plans.

Defined benefit plan

A defined benefit plan is a pension plan that determines the welfare benefits that employees receive when they retire. Previously, the organization and employees were aware of the lump sum amount that should be received during retirement through the use of a formula under defined benefit plans. The employer should consider the worker's age, tenure of employment, and salary details when calculating defined benefit plans. With this calculated amount, the entity guarantees to its workers that it will pay the fixed pension fund upon retirement. For the sake of the employees, the employer should put a set amount of money into specific investment accounts. That investment will also generate interest income. However, during retirement, the employer should pay the employee the committed fixed cash. If the actual invested amount is less than the expected amount, the plan administrator (employer) assumes responsibility for the difference.

Defined contribution plan

Employees in the defined contribution plan should contribute a percentage of their earnings on a monthly or annual basis throughout their employment period. In this plan, the entity also grants a cash share that is proportional to the employee's contribution. An employee should choose the various investment plans in which he or she wants to invest under the defined contribution plan. The benefit payments are not predetermined; they are based on the contributions made and the investment returns. The plan members (employees) bear the risk in defined contribution plans. Employers are not required to compensate for the difference between the actual and expected investment amounts.

Features of employer pension plan

People want to save for their post-retirement living expenses. Workers can live a more financially secure life if they have an emergency fund. The following are the features of an employer pension plan:

Assured income

Income that is guaranteed at the time of or after retirement is referred to as assured income. Employees who have employer pension funds will benefit from a consistent return. Workers can receive fixed income through employer pension plans.

Tax efficiency

Employer pension plans provide tax exemptions and tax deductions to employees and employers under various sections of the Federal Government's income tax laws. These tax breaks are available at the time of contribution and at the time of receiving the fund.

Liquidity

The majority of investment plans are liquid in nature. Employees can withdraw funds prior to the maturity date of investments for immediate needs. Employees can use their pension benefits in times of emergency.

Vesting age

The age at which employees begin receiving monthly pension payments is referred to as the vesting age. The vesting age varies depending on the plan. It is usually between the ages of 45 and 50.

Accumulation

The employer's contribution to investment schemes on behalf of employees will accumulate over the employee's working period. Employees can receive the invested amount as well as the interest earned over the years when the investment is withdrawn.

Payment period

The payment period is when the workers receive the amount invested. Retirement plans provide different investment periods for investments. Some pension plans permit partial or complete withdrawals prior to the payment period.

Social Security

Social Security is an insurance scheme handled by the Federal Government which provides benefits to retired workers, disabled workers, and survivors. Private, federal, state and local government sector workers can receive Social Security benefits if they pay to Social Security schemes. Workers should make contributions to Social Security schemes in the form of payroll taxes to receive Social Security benefits. Workers who have been paid in this scheme are eligible to receive benefits. Workers, disabled workers, and survivors are entitled to receive Social Security benefits on a monthly basis.

Context and Applications

This topic is significant in the professional exams for both undergraduate and postgraduate courses as well as competitive exams especially for

• Bachelors of Business Administration (Finance)
• Bachelors of Professional Accountancy
• Masters of Business Administration (Finance)
• Masters of Professional Accountancy

Practice Problems

Question 1: What is an employer pension plan?

1. Salary benefit
2. Compensation benefit
3. Retirement benefit

 Answer: Option (c) is correct.

Explanation: An employer pension plan is the retirement enjoyment offered by an employer to employees at the time of retirement or after retirement. It provides financial support to workers after the retirement period.

Question 2: What are the factors that need to consider while deciding on a defined benefit plan?

1. Education of the worker
2. Paycheck of the worker
3. Family of the employee

Answer: Option (b) is correct.

Explanation: While deciding the amount under pension plans, the employer should consider the age of the employee, the paycheck of the employee, and the length of service of the employee. Contribution under defined benefit plans depends on the earnings of the worker.

Question 3: Who bears the risk in the defined benefit plans?

1. Employer
2. Employee
3. Federal Government

Answer: Option (a) is correct.

Explanation: Under defined benefit plans, the employer needs to invest a lump sum amount in the name of the employee for their retirement planning. Due to inflation, the actual amount invested may be decreased. If the actual amount is shorter than the expected amount, the employer should take responsibility to settle the difference amount to the employee.

Question 4: What are the features of an employer pension plan?

1. Tax efficiency
2. Assured income
3. All of the above

Answer: Option (c) is correct.

Explanation: Tax efficiency, liquidity, assured income, and vesting age is some of the features of an employer pension plan. Employer pension plans provide tax benefits to workers and employers. Employer pension plans provide fixed income to workers after retirement.

Question 5: Who manages the Social Security scheme?

1. Employer
2. Federal Government
3. Employee

Answer: Option (b) is correct.

Explanation: Social Security is an insurance scheme handled by the Federal Government which provides benefits to retired workers, disabled workers, and survivors. Workers should be paid to Social Security to receive benefits.