Normal Costs of Pension Funding
Original post by Dennis Hartman of Demand Media
Pension funds can refer to any and all retirement savings plans. A more specific use refers to the retirement plans that employers sponsor and offer as employee benefits to their long-term employees. In particular, public pensions, which government workers rely on for retirement income, are major sources of investment in the economy. But pension funding also incurs costs that workers and employers must pay.
Cost to Workers
One of the most visible costs of pension funding is the money individual workers contribute from their paychecks. Employee pensions function as tax-deferred retirement investments, which means that workers contribute from each paycheck before paying taxes. This reduces their tax liability each year and allows them to pay taxes on the money as they receive it in retirement, when most taxpayers have lower earnings and pay lower tax rates. Worker contributions are one of the key costs in pension funding, providing the bulk of the money pension funds have to invest.
The second major cost of pension funding is the money that employers contribute to grow funds. This money pairs with employee contributions to fund pension plan investments. Just as workers gain tax advantages by deferring income until retirement, employers can save on their business income taxes by claiming deductions for the contributions they make to pension funding. This makes pension funding a valuable cost for employers, who can use contributions to manage their tax liabilities.
As money flows into a pension fund from employees and employers, a fund manager must decide what to do with it. This incurs the additional cost of fund management fees. Different types of pension funds feature different types of management, but in each case the fund manager seeks to grow the fund's principal balance by investing it in many different types of assets with the potential to increase in value. Employers pay pension fund management fees as part of their contribution to the process. Taking on this cost allows employers to benefit by recruiting skilled workers with the promise of a stable retirement plan.
A pension fund must deliver benefits to retirees according to a predetermined schedule. Some employers contract with third-party financial service companies to manage, account for and distribute pension funds. In the specific field of actuarial accounting, the money that a pension fund pays out is known as its normal cost. However, this is just the last regular cost that a pension fund or participant incurs in the process of delivering benefits to a retiree.
- Minnesota Public Pensions; Funding Principles; Mark Shepard; July 2010
- American Academy of Actuaries; Fundamentals of Current Pension Funding and Accounting For Private Sector Pension Plans; July 2004
- New Jersey Treasury: Funding the Pension System
About the Author
Dennis Hartman is a freelance writer living in California. His work covers a wide variety of topics and has been published nationally in print as well as online. Hartman holds a Bachelor of Fine Arts from Syracuse University and a Master of Arts from the State University of New York at Buffalo.
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