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Pensions can be defined as either contribution or benefit plans, with the present value depending on the performance of underlying securities. Defined contribution plans contain mutual fund shares and fixed-interest securities, while defined benefit plans invest in annuities. Withdrawals before the plan’s expiration date result in either the cash or insurance value, with insurance values adjusted for fees and penalties. Annual fees for insurers further deplete the present value of pensions.
Pensions come in many varieties, although these plans are typically classified as defined contribution or defined benefit plans. The present value of pensions depends in part on the performance of the underlying securities, such as stocks, bonds, certificates of deposits, and shares of mutual funds. Benefit plan defined values are also affected by different users insuring the account holder of different levels of payments at different times. Consequently, many pension plans include both an insurance value and a cash value; these two values are rarely the same.
Defined contribution plans are pensions into which an individual or entity makes regularly scheduled deposits. The account owner generally cannot access the funds before retirement age, but at that time they will receive a sum of money that is equal to the present value of the account’s holdings. In most cases, defined contribution plans contain mutual fund shares and fixed-interest securities, such as certificates of deposit (CDs). Mutual fund shares fluctuate daily as these funds actually invest in other securities like stocks and bonds, whereas CDs generally have core protections; CD account holders may lose money on these products due to early redemption penalties. With defined contribution plans, the present value of pensions reflects the current market value of the underlying securities after adjustments have been made to account for redemption penalties.
With a defined benefit plan, the account holder’s contributions are typically invested in annuities. The company issuing the annuity typically agrees to pay the account holder a lump sum of money on a specified future date. Even if the annuity contract loses money over time, the present value of pensions containing annuities often has more to do with the guarantees of the annuity contract than the present value of the values contained in the plan.
In some cases, defined benefit plan participants choose to make withdrawals before the plan’s expiration date. When this occurs, the participant receives the greater of the cash or insurance value. The cash value represents the present value of the pensions, while the insurance value represents an amount of money that the plan operator promises to pay to the plan participant in the event of an early withdrawal. Insurance withdrawal values are often adjusted to account for administrative fees and penalties. Pension plan operators assess annual fees for these insurers, and these costs further deplete the present value of pensions.
Smart Asset.
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