Pension Liability
See: Pension.
A pension liability is not that different from a liability owed by any corporation, like a debt obligation to pay back a bond, or 18 miles of tiny periscopes bought by Proctologists-R-Us. Corporations and governments both provide pensions for their employees. Very roughly, an employee making, say, 75 grand a year might get 10 percent of their salary a year in pension contributions from their employer.
Pensions are divided into two flavors. There are defined contribution pensions, one flavor of a 401(k) plan. In a defined contribution plan, the employee contributes, say, 10 percent of their salary...in this case, 7,500 bucks...and the employer might match it. That is, the employee takes 7,500 bucks off their total salary that's calculated for taxes, so instead of being taxed on $75 grand, they're taxed on $67,500, and they tax defer the $7,500 they put into their 401k plan.
They’ll still pay taxes on it eventually...but presumably when they're old and retired and poor and thus likely to pay lower tax rates than they would in their heavy working, high tax era at the peak of their careers.
So the employee saves 7,500 bucks, and the employer matches that $7,500 with $7,500 of its own. From the employer's perspective, that employee doesn't just get a $75,000 salary; they cost the employer $75k plus another 7,500 bucks of 401(k) pension matching expenses, or $82,500. And the employer pays it grumbling and wondering when the next version of robot comes out so they can replace this worker.
What happens to those savings? Well, employers usually provide employees with a menu of investment choices. They can hold all cash; they can invest in high growth relatively risky funds; they can invest in balanced growth and income funds, etc. The employee gets to choose from a supermarket of investment fund choices, or even buy individual stocks.
The key takeaway: at the end of however many years or decades of working, the employee is able to then take out from their pension whatever value that pension has accrued to be worth.
In a defined contribution fund, there is essentially no pension liability. The employee bears the stock market risk just like everyone else. The big controversies you read about in the press revolve around the second flavor of pension, called a defined benefit fund.
In a defined benefit situation, a number of irresponsible financial dealings take place where taxpayer money is often just given away with no thought of fiduciary duty. A given government worker works for the state for 30 years, eventually making $100k a year at the end, having received pension contributions all along the way, just as in the defined contribution system that corporations use, and as outlined above. But in a government defined benefit program, the employee is guaranteed a minimum rate of return in many situations. That is, they are guaranteed, say, 10% a year investment returns, even if the stock market is flat for 7 years, which happens all the time.
So that’s one flavor of pension liability that could likely bankrupt California and Illinois at some point not too far away. But it gets worse. There are other irresponsible things the states have done, like guarantee retirement return minimums or invest pension money in deadstock beanie babies.
So yeah. Pension liabilities are totally simple, easy-to-understand, uncontroversial, and can't possibly have an adverse effect on the world around us.
Hard to keep a straight face there.
Related or Semi-related Video
Finance: What are Pension Liabilities?23 Views
finance a la shmoop. what are pension liabilities? okay so if you haven't seen
our James Cameron directed and shmoop academy award-winning video called
what is a pension, we'll watch that first. before you continue. okay hi welcome back. [link to pension video]
a pension liability is not that different from a liability owed by any
corporation or even an individual. the corporations and governments both
provide pensions for their employees. very roughly an employee making say 75
grand a year might get 10% of a salary a year in pension contributions from the
employer. while pensions are divided into two
flavors. there are defined contribution pensions - one flavor of a 401k plan. in a
defined contribution plan the employee contributes say 10% of their salary and [defined contribution pension defined]
in this case that would be 7,500 bucks. and the employer might match it. that is
the employer takes 7,500 bucks off of their total salary that is calculated
for taxes so the employee instead of being taxed on 75 grand a year gets
taxed on sixty seven thousand five hundred they then defer the 7,500 bucks
they put into their 401k plan and well they'll still pay taxes on it eventually [equations on screen]
when they take it out but presumably when they're old and retired and poor
and thus likely to pay lower tax rates than they would in their heavy working
high tax hike tax rate era at the peak of their careers. so the employee saves
seventy five hundred bucks there or at least puts it away, and the employer
matches that 75 with seventy five hundred of its own. so from the employers
perspective that employee does not just get a seventy-five thousand dollar [equations on screen]
salary they cost the employer 75 grand plus another seventy five hundred bucks
of 401k pension matching expenses or eighty two thousand five hundred dollars.
and the employer pays it grumbling and wondering when the next version of robot
comes out so they can replace this worker ,well what happens to those
savings. well, employers usually provide employees with a menu of investment
choices they can hold all cash, they can invest in high-growth relatively risky [list of investment options shown]
funds, they can invest in balanced growth and income funds and so on and so on.
well the employee gets to choose from a supermarket of investment fund choices
or even buy individual stocks in their pension. the key takeaway at the
end of however many years or decades of working the employee is able to take out
from their pension whatever value that pension has accrued to be worth over
that time period. easy. in a defined contribution fund there is essentially [flow chart]
no pension liability. no pension liability to the corporation other than
each year doing the matching thing on that salary. okay?
the employee bears the stock market risk just like everyone else. the big
controversies you read about in the press revolve around the benefit flavor
of a pension, 2nd flavor here, called a defined benefit plan. in a defined
benefit situation a number of irresponsible financial dealings take [types of pensions listed]
place where taxpayer money is often just given away with no thought of fiduciary
duty or obligation to ,you know being respectful of the taxpayers hard-earned
money. a given government worker works for the state for 30 years eventually
making a hundred grand a year at the end having received pension contributions
all along the way just as in the defined contribution system that corporations [equation on screen]
use as outlined above .only in a government defined benefit program the
employee is guaranteed a minimum rate of return in many situations. that is the
employee is guaranteed say 10% a year in investment returns even if the stock
market is flat or down or bad for 7 ,10 15 ,years whatever. that happens all the
time, yet the taxpayers on the hook to give
them that guaranteed 10 percent a year compound rate. well at a 10 percent of [flow chart]
your compound rate after seven years well let's say the actual stock market
return was only 7 percent and the employee lagged 3 percent a year each
year compounded well that would be a lot that the state would then owe them so
that's one flavor of pension liability that could likely bankrupt California
and Illinois at some point not too far away because the pension liabilities [California and Illinois pictured.]
there are enormous. and it gets worse there are other irresponsible things the
states have done like guarantee retirement return minimums or investing
pension money in dead stock beanie babies. it was a really bad investment by
CalPERS there huh. so yeah pension liabilities are a
totally simple easy to understand uncontroversial thing and while they
can't possibly have an adverse effect on the world around us right? sorry hard to
keep a straight face there. [man talks out the side of his mouth]
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