Defined Contribution Pension plans

IAS 26: Defined contribution pension plans are post-employment benefit plans under which an entity pays fixed contributions into a separate entity (a fund) and will have no legal or constructive obligation to pay further contributions if the fund does not hold sufficient assets to pay all employee benefits relating to employee service in the current and prior periods.

Further explanations

In a defined-contribution plan, the employer specifies how much it will contribute to the pension plan. In other words, the employer’s total payments under the plan (and employee contributions, if any) are known up front. Defined Contribution Pension plans

The amount of the pension benefit to retirees is determined at the time of retirement and is based on the amount of the accumulated contributions plus total investment returns (or losses) the fund has generated over time.

The defined-contribution plan defines only the employer’s (and employee’s) contribution and makes no commitment regarding the amount of benefits to be paid out upon retirement. Once the employer has made the specific contributions required by the plan, it has no further obligations. The active employees bear the risk associated with not knowing what their pension benefits will be until they retire.

In practice, a typical defined-contribution plan deducts employee contributions directly from their pay, with a pre-defined portion of these contributions matched by the employer. Defined Contribution Pension plans

Accounting for defined contribution pension plans

Accounting is straightforward for defined contribution pension plans. The employer simply contributes amounts each year based on the contribution formula established by the plan, so the employer’s annual cost (pension expense) is simply the amount that it is required to contribute to the plan. The employer only records a liability to the extent that its required annual contributions have not yet been paid, essentially an account payable to the pension fund. Depending on the pension plan employees may also contribute a part of the pension expenses. Additional voluntary contributions may also be allowed, although many fiscal rules can apply.

Main financial statements

The report of a defined benefit plan should contain either: [IAS 26 17] Defined Contribution Pension plans

  • a statement that shows the net assets available for benefits, the actuarial present value of promised retirement benefits (distinguishing between vested benefits and non-vested benefits) and the resulting excess or deficit; or
  • a statement of net assets available for benefits, including either a note disclosing the actuarial present value of promised retirement benefits (distinguishing between vested benefits and non-vested benefits) or a reference to this information in an accompanying actuarial report. Defined Contribution Pension plans

Actuarial valuation (in a pension fund)

If an actuarial valuation has not been prepared at the date of the report of a defined benefit plan, the most recent valuation should be used as a base and the date of the valuation disclosed. The actuarial present value of promised retirement benefits should be based on the benefits promised under the terms of the plan on service rendered to date, using either current salary levels or projected salary levels, with disclosure of the basis used. The effect of any changes in actuarial assumptions that have had a significant effect on the actuarial present value of promised retirement benefits should also be disclosed. [IAS 26 18] Defined Contribution Pension plans

The report should explain the relationship between the actuarial present value of promised retirement benefits and the net assets available for benefits, and the policy for the funding of promised benefits. [IAS 26 19] Defined Contribution Pension plans

Fair value

Retirement benefit plan investments should be carried at fair value. For marketable securities, fair value means market value. If fair values cannot be estimated for certain retirement benefit plan investments, disclosure should be made of the reason why fair value is not used. [IAS 26 32] Defined Contribution Pension plans

Gross premiums

The annual (gross) premium is determined by multiplying the (maximum) age-dependent percentage by the pensionable base for that year (see table hereafter). Besides this premium the employer has to pay the costs of risk insurances and administration. If the pension capital produces a yield of 4%, a defined contribution scheme is in principle equivalent to an average pay scheme. There is also a table based on a yield of 3% with higher maximum percentages, for the use of which additional rules apply.

Besides the premium tables mentioned therefore it is also possible to determine a flat rate premium. The flat rate premium cannot exceed the maximum premium for the youngest employee, therefore (considered the youngest possible participating employee being 21) with a maximum of 4.4% or 7.7%.

Defined Contribution Pension plans

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