An actuarial pension plan is a pension plan that has been reviewed by an actuary to determine the funding status of the plan. This type of plan is also known as a "funded" pension because the actuary is able to determine whether the pension will be able to pay its obligations. Actuaries are well-suited for reviewing plans because actuaries are trained to mathematically assess the future. Since a pension is only valuable if funds are paid, having an actuarial review is very important.
What is a Pension Plan?
To review, a pension plan is income provided to someone on a periodic basis, often monthly, once the person meets the qualifications to begin receiving the income. A pension is often associated with retirement income, since that is when most people begin receiving their pensions.
Many people receive a pension from their employers. The pension is a form of deferred compensation in which the employer agrees to pay the employee installment payments sometime in the future. If a portion of the contribution comes from the employee, this allows the employee to enjoy tax benefits. He or she will only pay taxes on the income once, at retirement, rather than twice.
How Pensions are Financed
There are two types of pension plan funding; funded pension plans and unfunded pension plans.
- Unfunded Pension Plans. This type of plan does not have money set aside to pay recipients. You might say there is no savings account to draw from. While this sounds bad, it's actually how most government pension plans are funded. Social security recipients, for example, are paid by current worker contributions. If you are working right now, the social security money withheld from your paycheck goes to a retiree. The money is not being set aside for your retirement in the future.
- Funded Pension Plans. This is a plan that does have money set aside to pay future obligations. An actuary will review the plan to determine how well the plan is funded and whether any changes need to be made. This process is called an actuarial valuation.
Actuarial Pension Plan: Actuarial Valuation
Since a funded pension plan does not have taxpayers to draw money from, an actuary must review the pension to make sure it's credible. The actuary will perform an actuarial valuation, which includes the following parts:
- Determine funding position. This is a basic accounting of the plan by comparing assets to liabilities.
- Determine funding requirements. This requires far more calculations and is why an actuary is needed. Even if a plan is well funded today, that doesn't mean it will remain so in the future. The actuary studies all of the numbers to determine if changes need to be made to keep the plan solvent.
Actuarial Valuation Report
One of the principle jobs of the actuary when studying an actuarial pension plan is to write an actuarial valuation report. This report provides an in depth review of the plan so that customers can fully evaluate the plan.
An actuarial valuation report includes many parts, such as:
- Name of the plan and who sponsors it.
- The name of the actuary who studied the plan.
- Actuarial results, which includes: present value of future benefits, figuring out the minimum financing needed to keep the pension funded, and the assets and liabilities of the pension.
- The assumptions made by the actuary. This is important in understanding how all the calculations were made.
- Participant Data. Understanding who is receiving income from the pension, and how the characteristics of the group will change over time is also very important.
- An executive summary of the results of the valuation.