CFA Level 1 Study Notes – Portfo ...
Study Session 18 Reading 51 (48 in 2022) – Portfolio Management: An Overview... Read More
Employees of both private and public companies often save and invest for retirement via defined contribution (DC) pension plans in which they assume the investment risk. In the case of a defined benefit (DB) pension plan, the responsibility and investment risk fall on the employer. It is up to the employer to provide the defined benefits to employees on retirement.
Defined Contribution Pension Plan
A Defined Contribution (DC) pension plan is an investment vehicle in which the amounts invested, or the contributions that the employee makes to the plan, are defined or specified, but the benefits are not predetermined. The objective of the pension plan is to accumulate wealth by investing a portion of wages while working to provide income during retirement. Unlike a Defined Benefit (DB) pension plan, where the retirement benefits are predetermined based on factors such as salary and years of service, a DC plan places the investment risk on the employee. The employee is responsible for ensuring that their contributions and investment growth are sufficient to provide the desired income upon retirement. The final retirement income in a DC plan depends on the contributions made, investment performance, and the choices made by the employee regarding investment options within the plan.
Defined Benefit Pension Plan
In a DB pension plan, the employer has an obligation to provide certain benefits to employees when they retire. The future benefit is specified or defined. The investment management of DB plans has to consider the timing of its future liabilities or cash flows by assessing the age of its plan members. If, for example, a DB pension plan has a lot of young members, the investment time horizon of the plan may be quite long. The plan investment manager may try to match the cash flow requirements of the plan with cash-flow-producing assets such as bonds. This checks the capacity of portfolio assets to offset portfolio liabilities.
Question
Which of the following best describes the investment risk of a DB pension plan?
A. The employer assumes the investment risk.
B. The employee assumes the investment risk.
C. The employer and the employee share the investment risk.
Solution
The correct answer is A.
In a DB pension plan, the employer must ensure there are sufficient assets to match the future defined benefits payable to employees upon retirement.
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2021-07-23
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2021-07-17
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2021-07-16
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