Pension Scheme Benefits - Essay Example

?Finance and Accounting What are defined benefit and defined contribution pension schemes? Compare them from the perspective of a member of a pension scheme. Defined Benefit Pension Scheme The distinction feature of defined benefit pension scheme is in the procedure of payment and the inputs of factors that determines the amount of money that a pensioner will receive. Largely, it is the employer who would commit him or her self to either choosing to pay the employee a defined benefit pension or not. Once selected, the employer pays the employee upon pension, a fixed amount of money every month for as long as the pensioner is alive (Cox, Jonathan and Stephan, 2011, p. 212). There are several factors that determine the amount of money that each retiree receives. This means that the fact that the defined benefit pension scheme promotes the payment of fixed amount of money every month does not mean that all organizations agree to pay a fixed amount of money to all their employees. Even within the same organization, not all employees receive the same amount of money. The actual contract of fixed amount payment is therefore between the employer and each employee; rather than between the employer and all members on the staff. To create a difference between how much each employee would take upon retirement, there are a number of mechanisms used to calculate the monthly. The commonly procedure is for employers to multiply the number of years each employee worked by a constant pound value (Diamond and James, 1985, p.12). For example an employee may choose to multiple the number of years by ?120. In this case, an employee who worked for 20 years will receive 20 x 120 which is equal to 2400 every month. Defined Contribution Pension Scheme Unlike the defined benefit pension, the defined contribution pension scheme does not guarantee a fixed monthly amount of money. Somehow, the name of this scheme, which is defined contribution, explains the technique behind this scheme and that is, an employee would receive a certain amount of money based on certain contribution made. This calls for the setting up of a fund, such as a pension fund. The employer agrees to pay a certain amount of money into the fund each year. In some jurisdictions, the employee is also free make similar contributions into the fund. The amount of money that the employee would receive each month upon retiring therefore depends on the amount of income that the accumulated money in the fund can generate. A very special feature that defined contribution pension plan possesses is that the recipient of the benefit is also entitled to any investments that the fund that was set can generate. For instance if the fund was invested into a mortgage, the amount of interest that the mortgage investment generates also becomes part of the calculation when determining how much the retiree will receive at the end of each month after retiring. This therefore leaves employers who want to use this pension scheme as a source of motivation for their employees to look for highly beneficial investment funds that can guarantee their employers much revenue for selection. In the absence of such an investment fund, the only amount that the employee can be assured of would be the accumulated contribution made by the employer or by both the employer and the employee (Amoroso, 2003). Comparison between two types from perspective of members of the pension scheme Primarily, members of the pension scheme are made up of employers and employees. In the sight of each of these people, are there a number of factors that they would consider in either agreeing to go for defined benefit pension plan or defined contribution pension plan. Most commonly, the outstanding feature that these two people look at is what is referred to as market risk. Chuck (2012) notes that “market risk is the risk associated with changes in the value of the investments in the plan.” Technically, both types of pension plans are special forms of investments where by in the defined benefit pension plan, the investment could be calculated in terms of market value of the constant that is used in determining the fixed amount and in the case of defined contribution, the investment is the interest that the yearly contributions would fetch. With reference to the defined benefit pension plan, members of the scheme may view the play from a perspective whereby the value of the fixed amount of money to be paid them may faced the market risk of devaluation and inflation. That is, if a retiree is to receive a fixed amount of ?2000 each month for say 12 years, there is a clear indication that the value of ?2000 would not be the same from the first month the money is paid to the last month the retiree would receive the amount before dying (Bierwag, 2007, p. 132). This generally represents the negative effect of this form of pension plan. From another perspective, members of the scheme may prefer the defined benefit pension plan because it guarantees them that no matter the prevailing economic situation, they are going to receive a fixed amount that would never bounce. Members of the defined contribution pension scheme also have two perspectives from which to view this kind of pension plan. The first has to do with reasons why they would prefer this type to the defined benefit pension plan. The reason is in the fact that if a very careful selection is made of the kind of investment to channel the yearly contribution, there may be a guarantee of making as much amount of money as possible. In this case, there is no limit on the benefit and so the amount of monthly benefit may grow as huge as the investment policy. On the other hand, there is a risk with market falls in investments. A clear instance of such as situation is what the global economy experienced in 2008 when there was virtually a freeze on major investments such as real estate, bonds and stocks. On the part of the employers the perspectives from which they view the two types of pension plans is not very different from that of the employees. Some few considerations however has to do with the fact that most of employers who are not into very large organizations may not want to be obliged by a fixed monthly payment for their employees when they cannot be sure of the future performance of their company and so would not want to opt for the defined benefit plan. Rather, they would go for the defined contribution plan where the amount of money that the employee would receive will not be defined directly by how much contribution is made but how much income the investment fund can generate. Lastly those who have well established organizations would opt for defined benefit plan because they can be guaranteed of an uninterrupted amount to pay that will not have to be increased on mandatory basis. 2. Why do investments need to be regulated? How are they regulated in the UK? The need to regulate investments is important for two major reasons. First, is to ensure that there is uniformity in the operations and activities of investment companies and investment portfolios. This is referred to as the standardization of operations (Ellwood, 1985, p. 111). Since investments have an ultimate purpose of helping in creating wealth for investors, it is very important that the programs and activities of such investments are regulated that regulatory institutions to ensure that the core purposes of expected mandates of the investors are achieved. For example in the United Kingdom, one is likely to be involved a number of investment portfolios such as venture capital funds, private equity and hedge funds. Once regulations to monitor and standardize the operations of these investments are in place, the probability that these investments are going to be managed in such a way that they can lead the investor on the path of profit is higher. This is because if operators of the various investment funds are regulated, they will be pushed to work hard to meet the requirements and stipulations of the regulation. The American case study can be used as an example when in 2009 The Hedge Fund Transparency Act was passed. This Act was to ensure that players in the investment industry matched up to certain operational standards else their licenses would be taken away from them (Morrison and Foerster, 2009). It is reported that the first achievement that the regulation recorded was improvement in the profits on investments. This actually means that when regulations are put in place, investment advisers will be in a better position to ensure value for money for their clients. As clients for investment companies, the will and interest of investors cannot be taken lightly at all. Interestingly, the survival of the United Kingdom economy is very much dependant on the financial inputs that these investors make into the economy. It is for this reason that their interests ought to be protected and defended. What this also means is that any attempt to help the investor gain more through regulations is an attempt make the economy grow and vice versa. It is again for this purpose that regulations must be in place to ensure transparency in the activities of investment companies. It is regrettable to note that “currently, most private funds are not required to register with the SEC because they are exempt from the Investment Company Act’s definition of an “investment company” (Morrison and Foerster, 2009). Once such a situation exists, the tendency that such unregistered and for that matter unregulated companies would be involved in transactions and deals that are not transparent and clear to the general public and clients. In such a situation, the absence of registration and regulation puts clients at an unfavourable position where they have no legal locus to demand for accountability and fairness if they feel they are being cheated in their investment ventures. The ultimate decision that most of these investors have taken has been to redraw their investments from sources they cannot guarantee as being genuine and authentic. The long lasting effect that this also is that the economy of the State becomes crippled as investors continuously pull out of investment ventures. Presently, there are a number of models that are used to regulate investments in the United Kingdom. The first and commonest of such forms has to do with the use of documented Acts and Laws. A clear example is the Financial Services and Markets Act 2000. This Act seeks to regulate the activities of investments by defining in clear terms activities that are permitted and those that are prohibited in the investment sector in the United Kingdom. As part of the regulation, there are clearly defined sanctions for people who violate any part of the Act that seeks to regulate investment in the United Kingdom. For instance Article 24 of the Financial Services and Markets Act 2000 is quoted as follows: (1) A person who is neither an authorised person nor, in relation to the regulated activity in question, an exempt person is guilty of an offence if he— (a) describes himself (in whatever terms) as an authorised person; (b) describes himself (in whatever terms) as an exempt person in relation to the regulated activity; or (c) behaves, or otherwise holds himself out, in a manner which indicates (or which is reasonably likely to be understood as indicating) that he is— (i) an authorized person; or (ii) an exempt person in relation to the regulated activity Source: (Financial Services and Markets Act 2000). REFERENCE LIST Amoroso, V. 2003. Termination insurance for single-employer pension plans: Costs and benefits. Transactions, Society o j Actuaries 35:71-83. Bierwag, G. 0. 2007. Immunization, duration and the term structure of interest rates. Journul of Financial and Quantitative Analysis (December): 725-42. Chuck R. 2012, Defined Benefit vs Defined Contribution Pension Plans, [Online] http://chuck.hubpages.com/hub/Defined-Benefit-vs-Defined-Contribution-Pension-Plans [May 12, 2012] Cox, J. C., Jonathan E. I., and Stephan A. R. Duration and the measurement of basis risk. Journal of Business 52 (2011): 51 -61. Diamond, P, and James M.. 1985, Insurance aspects of pensions. In Pensions, labor, and individual choice, edited by David Wise. Chicago: University of Chicago Press. Ellwood, D. T. 1985. Pensions and the labor market: A starting point. In Pensions, labor, and individual choice, edited by David Wise. Chicago: University of Chicago Press. Financial Services and Markets Act 2000, 2012, The National Achieves. [Online] http://www.legislation.gov.uk/ukpga/2000/8/part/II/crossheading/offences [May 14, 2012] Morrison and Foerster, 2009, Regulating Private Funds and their Investment Advisers, [Online] http://www.mofo.com/regulating-private-funds-and-their-investment-advisers-a-summary-of-recently-proposed-legislation-02-10-2009/ [May 13, 2012] Read More