How much money has been contributed into the fund when Anne concludes her service?
How much money is in the fund when Anne starts drawing her pension benefit?
How many years of benefits can the fund pay before it runs out of money?
How much money will be paid out before the fund runs out of money?
When Anne begins retirement, is the plan fully funded? To answer this I made a very simple model in Excel. ANSWERS:
$200,000. Anne contributes $208.33 per month, as does her employer. There are 480 monthly contributions of $208.33, or $100,000 from both Anne and her employer.
$492,484. If balances in the fund earn compound interest at the annual rate of return of 4%, the balance will more than double over the 40 year period.
The fund will run out of money after 17 years, when Anne is 82 years old.
The fund will pay Anne $676,667 in benefits. Remember that the balance continues to compound at 4% during the payout period. So the funds deposited more than triple in value over Anne’s 57 years as a plan participant.
It depends! If actuarial expectations for Anne’s life expectancy have not changed, and if fund investment results (4% per yaer) have been realized exactly as modeled when the plan was established, then the plan should have precisely enough money to pay Anne until she passes away. Or in the language of finance and accounting, the Assets on Anne's first day of retirement ($492,484) will precisely equal the present value of the future liabilities ($676,667) discounted at 4% back to the date of retirement. Let’s look at four additional scenarios. What happens if we only change one element of the plan …
Scenario # 2: Returns on the investments average 6% instead of 4%?
Scenario #3: Returns on the investments average 2% instead of 4%?
Scenario #4: The employer (due to decisions in Harrisburg) stops contributing for ten years in the middle of Anne’s employment
Scenario #5: Harrisburg is feeling generous and increases the benefit multiplier from 2.0% to 2.5%, without adding any funding to the system.
Pension plans can be derailed by many factors, including:
Under-performance of the investment portfolio
Political interference in employer contributions
Granting of new benefits
To determine the health of a pension fund, you must compare the present assets to the present value of future liabilities (payments).
A healthy fund should have 100% of the assets needed right now to meet all of its future liabilities. If you made it all the way to end of this post, you deserve a gold star!