Definition
Allocated benefits represent the payments allocated to participants in a defined-benefit pension plan as the insurance company receives premiums. These benefits are essentially “paid up,” guaranteeing an employee a pension upon retirement, regardless of the company’s financial condition thereafter.
Examples
- Corporate Pension Plan: An employer provides a defined-benefit pension plan to its employees. As the company pays insurance premiums, the benefits are allocated to the employees. Even if the company goes bankrupt, the employees will still receive their pensions upon retirement.
- Government Pension Plan: In some government-run pension schemes, benefits are allocated as contributions are made by both the employer and employees. The guaranteed portion ensures that retirees receive their entitled benefits as scheduled.
Frequently Asked Questions
What is the primary advantage of allocated benefits in a defined-benefit pension plan?
The main advantage is the assurance provided to employees that they will receive their pensions upon retirement, even if the employer faces bankruptcy or financial distress.
Are allocated benefits similar to defined contribution plans?
No, in allocated benefits under defined-benefit plans, the benefits are predetermined and guaranteed, while in defined contribution plans, the benefits are based on contributions and investment performance.
Can allocated benefits be used for other forms of insurance plans?
While primarily used in pension plans, the concept of allocated benefits can be applied in other types of insurance where premiums are allocated to specific benefits, ensuring payments regardless of future conditions.
What happens if an insurance company handling allocated benefits goes out of business?
If the insurance company fails, the benefits may be safeguarded by state insurance guaranty associations, although coverage limits and protections vary by state.
How are allocated benefits calculated?
Allocated benefits are determined based on a formula considering factors such as salary history, duration of employment, and the age of the employee.
Related Terms
- Defined-Benefit Pension Plan: A retirement plan where employee benefits are computed using a formula that considers factors such as length of employment and salary history.
- Premium: Regular payments made to an insurance company in return for insurance coverage.
- Pension Fund: A fund from which pensions are paid, accumulated from contributions from employers, employees, or both.
- Retirement Benefits: Financial benefits that an employee receives upon retirement.
- Vesting: The process by which an employee earns the right to receive full benefits from the pension plan.
Online References
- Investopedia on Defined-Benefit Plan
- U.S. Department of Labor: Pension Benefit Guaranty Corporation
- IRS: Defined-Benefit Plan Resource
Suggested Books for Further Studies
- “The Pension Trustee’s Handbook” by Robin Ellison
- “Pensions in Crisis” by Karen Ferguson
- “The Handbook of Stable Value Investments” by Frank J. Fabozzi
Fundamentals of Allocated Benefits: Pension and Retirement Fundamentals Quiz
### In a defined-benefit pension plan with allocated benefits, who guarantees the pension payments?
- [ ] The employer
- [x] The insurance company managing the plan
- [ ] The employees
- [ ] The financial market investments
> **Explanation:** In a defined-benefit pension plan, the insurance company managing the plan guarantees the pension payments through premiums paid by the employer.
### What would be a defining feature of an allocated benefit in a pension plan?
- [x] The benefit is guaranteed to be paid regardless of the employer's financial condition.
- [ ] The benefit is based solely on contributions made by the employee.
- [ ] The benefit amount fluctuates with market conditions.
- [ ] The benefit can be withdrawn anytime before retirement without penalties.
> **Explanation:** An allocated benefit is guaranteed and protected from the employer’s financial status, ensuring payment upon retirement.
### What primary factor makes defined-benefit plans different from defined contribution plans?
- [ ] Investment choices available to employees
- [ ] Contribution limits
- [x] Predetermined and guaranteed benefits
- [ ] Availability of loans from the plan
> **Explanation:** Defined-benefit plans are characterized by predetermined and guaranteed benefits, unlike defined contribution plans which depend on contribution and investment performance.
### What advantage do allocated benefits provide to employees?
- [ ] Flexibility in investment choices
- [ ] Higher risk-reward ratio
- [x] Guaranteed retirement income
- [ ] Immediate access to funds
> **Explanation:** Allocated benefits ensure employees have a guaranteed retirement income, which is a secured financial benefit.
### How does vesting affect allocated benefits?
- [ ] It allows immediate access to benefits upon employment
- [ ] It increases the payout amount over time
- [x] It entitles employees to benefits after meeting specific criteria
- [ ] It influences the level of premiums paid
> **Explanation:** Vesting determines when employees earn the right to receive full benefits from the plan, impacting their allocated benefits.
### When are benefits allocated in a defined-benefit plan?
- [ ] When the employee retires
- [x] As premiums are received by the insurance company
- [ ] At the beginning of employment
- [ ] Annually at the fiscal year-end
> **Explanation:** Benefits are allocated as premiums are received by the insurance company, guaranteeing pension payments by retirement.
### What ensures the payment of allocated benefits if a company goes out of business?
- [ ] Employee savings
- [ ] Government subsidies
- [x] The fact that benefits are insured by an insurance company
- [ ] Employer’s contingent reserve
> **Explanation:** The insurance company managing the plan ensures the payment of allocated benefits regardless of the company’s financial state.
### Where can allocated benefits in a pension plan often be insured?
- [x] State insurance guaranty associations
- [ ] Private investment accounts
- [ ] Employee savings accounts
- [ ] Employer's liability insurance
> **Explanation:** Allocated benefits are often insured with state insurance guaranty associations, providing an additional layer of trust.
### What typically determines the amount of allocated benefits?
- [ ] Employee's choice of investment options
- [ ] Current stock market performance
- [x] A formula considering salary history, duration of employment, and employee age
- [ ] Contributions made by the employer
> **Explanation:** The amount of allocated benefits is usually determined by a formula that takes into account several factors such as salary history, employment duration, and age.
### Under what condition can an employee receive an allocated benefit?
- [ ] Only when the employer is financially stable
- [ ] Immediately upon hiring
- [x] Once the vesting criteria are met and the employee retires
- [ ] Upon maturity of a life insurance policy
> **Explanation:** An allocated benefit can be received once the vesting criteria are met by the employee and upon retirement.
Thank you for exploring the concept of allocated benefits in defined-benefit pension plans and trying out the quiz questions! Keep advancing your knowledge in employee benefits and retirement planning!
