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Finance: What are Pension Liabilities? 23 Views


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Description:

What are pension liabilities? Pension liability is the difference in what an entity owes in pension payments versus how much they have on hand to cover the payments. Hopefully, and usually, this number is positive, meaning the company has more than what they need to cover their employees’ pensions upon retirement.

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Transcript

00:00

finance a la shmoop. what are pension liabilities? okay so if you haven't seen

00:08

our James Cameron directed and shmoop academy award-winning video called

00:12

what is a pension, we'll watch that first. before you continue. okay hi welcome back. [link to pension video]

00:20

a pension liability is not that different from a liability owed by any

00:26

corporation or even an individual. the corporations and governments both

00:30

provide pensions for their employees. very roughly an employee making say 75

00:36

grand a year might get 10% of a salary a year in pension contributions from the

00:41

employer. while pensions are divided into two

00:43

flavors. there are defined contribution pensions - one flavor of a 401k plan. in a

00:49

defined contribution plan the employee contributes say 10% of their salary and [defined contribution pension defined]

00:55

in this case that would be 7,500 bucks. and the employer might match it. that is

00:59

the employer takes 7,500 bucks off of their total salary that is calculated

01:03

for taxes so the employee instead of being taxed on 75 grand a year gets

01:08

taxed on sixty seven thousand five hundred they then defer the 7,500 bucks

01:13

they put into their 401k plan and well they'll still pay taxes on it eventually [equations on screen]

01:19

when they take it out but presumably when they're old and retired and poor

01:23

and thus likely to pay lower tax rates than they would in their heavy working

01:28

high tax hike tax rate era at the peak of their careers. so the employee saves

01:32

seventy five hundred bucks there or at least puts it away, and the employer

01:36

matches that 75 with seventy five hundred of its own. so from the employers

01:40

perspective that employee does not just get a seventy-five thousand dollar [equations on screen]

01:44

salary they cost the employer 75 grand plus another seventy five hundred bucks

01:50

of 401k pension matching expenses or eighty two thousand five hundred dollars.

01:54

and the employer pays it grumbling and wondering when the next version of robot

01:59

comes out so they can replace this worker ,well what happens to those

02:02

savings. well, employers usually provide employees with a menu of investment

02:07

choices they can hold all cash, they can invest in high-growth relatively risky [list of investment options shown]

02:12

funds, they can invest in balanced growth and income funds and so on and so on.

02:16

well the employee gets to choose from a supermarket of investment fund choices

02:20

or even buy individual stocks in their pension. the key takeaway at the

02:24

end of however many years or decades of working the employee is able to take out

02:29

from their pension whatever value that pension has accrued to be worth over

02:34

that time period. easy. in a defined contribution fund there is essentially [flow chart]

02:39

no pension liability. no pension liability to the corporation other than

02:45

each year doing the matching thing on that salary. okay?

02:48

the employee bears the stock market risk just like everyone else. the big

02:52

controversies you read about in the press revolve around the benefit flavor

02:56

of a pension, 2nd flavor here, called a defined benefit plan. in a defined

03:02

benefit situation a number of irresponsible financial dealings take [types of pensions listed]

03:07

place where taxpayer money is often just given away with no thought of fiduciary

03:13

duty or obligation to ,you know being respectful of the taxpayers hard-earned

03:18

money. a given government worker works for the state for 30 years eventually

03:22

making a hundred grand a year at the end having received pension contributions

03:26

all along the way just as in the defined contribution system that corporations [equation on screen]

03:31

use as outlined above .only in a government defined benefit program the

03:36

employee is guaranteed a minimum rate of return in many situations. that is the

03:41

employee is guaranteed say 10% a year in investment returns even if the stock

03:47

market is flat or down or bad for 7 ,10 15 ,years whatever. that happens all the

03:53

time, yet the taxpayers on the hook to give

03:56

them that guaranteed 10 percent a year compound rate. well at a 10 percent of [flow chart]

04:00

your compound rate after seven years well let's say the actual stock market

04:05

return was only 7 percent and the employee lagged 3 percent a year each

04:10

year compounded well that would be a lot that the state would then owe them so

04:15

that's one flavor of pension liability that could likely bankrupt California

04:20

and Illinois at some point not too far away because the pension liabilities [California and Illinois pictured.]

04:24

there are enormous. and it gets worse there are other irresponsible things the

04:28

states have done like guarantee retirement return minimums or investing

04:32

pension money in dead stock beanie babies. it was a really bad investment by

04:37

CalPERS there huh. so yeah pension liabilities are a

04:40

totally simple easy to understand uncontroversial thing and while they

04:44

can't possibly have an adverse effect on the world around us right? sorry hard to

04:49

keep a straight face there. [man talks out the side of his mouth]

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