There are two basic types of pension plans: defined-contribution plans and defined-benefit plans. The plans differ in how benefits to retired employees (formal: pension recipients) are determined/calculated, and who bears the ultimate risk associated with the number of future benefits to be paid to retired employees.
For accounting purposes, defined-benefit plans can be further broken down into sole-sponsored, jointly sponsored and multi-employer plans. These sub-types dictate how a sponsor accounts for the plans, and differ in the number and types of entities sponsoring the plan as well as how risk is shared between them.
For financial reporting purposes, there is only one concern, pensions and their reporting are to complex!
General concerns represent:
- Contributions by employers (government, industry-wide or individual entity plans) and employees is a matter of continuous debate and (co-)sponsors may be requested to increase their average contributions when shortfalls or lower earnings occur.
- Because of the long-term nature of pensions in general small increase of pension charges over a long period of time to all sponsors are created, to establish trust in the system.
- The main issues in pension plans are the aging of (retired) members and the low inflow of younger employees joining a pension plan over a significant part of their employed life.
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.
Read more: Defined-contribution plans
Defined benefits plan
A defined-benefit plan specifies the pension amount that employees receive in retirement, and the employer guarantees this defined amount. In other words, the risk of ultimately funding the promised defined benefits is borne by the employer, which is the plan sponsor.
Read more: Defined-benefit plans
Sole-sponsored Pension Plan
A sole-sponsored pension plan is a defined-benefit plan in which only one group of companies (parent and closely held subsidiaries) or one company bears the risk and rewards with the plan members, who are current and retired employees. This type of defined-benefit plan is most often seen in the private sector where the employer is the sole sponsor, while a defined-benefit plan in the public sector is mostly organised in jointly sponsored pension plans. There are many similarities with the jointly sponsored pension plans (having a representative governance body), except off-course sharing risk and rewards between sponsors and/or members.
Jointly Sponsored Pension Plan
A jointly sponsored pension plan is a defined-benefit plan in which an employer shares risks and rewards in the plan equally with the plan members, who are current employees and retirees. Since there are usually many individual plan members and sponsors, a representative governance body is typically formed to represent all of them collectively as a plan sponsor (for example an employee union or federation (employees) and the key industry body (employers)). This type of defined-benefit plan is most often seen in the public sector, while a defined-benefit plan where the employer is the sole sponsor is more typical of the private sector (see sole-sponsored pension plan). However, jointly sponsored pension plans are also quite common vehicles in industry wide organised pension plans (for example building and construction industry or mining industry).
Read more: Jointly sponsored pension plans
A multi-employer pension plan is a defined-benefit plan where two or more employers act as plan sponsors for their respective groups of employees. All of the employers contribute into a single pension fund, and the amount of these contributions is determined by legislation or one or more collective-bargaining agreements.
Read more: Multi-employer pension plan