Variable-Benefit Plan
A pension plan where the payout varies according to the performance of the investments made as part of the plan
What is a Variable-Benefit Plan?
A variable-benefit plan is a type of pension plan wherein the payout that the beneficiary is entitled to is subject to change according to the performance of the investments made as part of the plan. The benefit that the pensioner is entitled to changes in tandem with market fluctuations, hence the use of the term “variable” in the name of the policy.
Unlike a defined benefits plan, where the beneficiary is guaranteed a fixed income stream after retirement, a variable-benefit plan offers a non-constant or “variable” income stream after retirement.
Summary
- A variable-benefit plan is a type of pension plan wherein the payout that the beneficiary is entitled to is subject to change according to the performance of the investments made as part of the plan.
- A pensioner has both greater freedom and responsibility under a variable-benefit plan since the investment decisions they make directly impact their future pension payments.
- The holder is allowed to manage their own account by themselves.
What is a Pension Plan?
A pension plan is a financial stability scheme for employees. Under such schemes, the employer or the sponsor is required to make contributions to a pool of funds. The funds are then invested for the future benefit of an employee at that organization.
Structure of Variable-Benefit Plans
Variable-benefit plans are different from defined-contribution plans. In the former, the holder is allowed to manage their own account by themselves. It is a different model from that of a defined-benefit plan, which provides the planholder with a predetermined set of payments upon his retirement. The payments do not change from period to period, and the amount of each payment is based on a set eligibility formula that is different from one based on investment returns.
Under a variable-benefit plan, an accrual rate is determined and used. Here, the sponsor, who is the employer, contributes a given percentage of each participant’s salary to the plan on an annual basis.
Risk Associated with Variable-Benefit Plans
In variable-benefit plans, the risk gets shifted from the employer to the employee. Also, under variable-benefit plans, it is possible that the employee may end up with lesser money than with defined-benefit plans. This may happen due to poor investment choices made by the pensioner.
However, there is an upside, as the pensioner also possesses the authority and prerogative to make better investment choices, and, therefore, end up with better benefits than usual. Thus, under variable-benefit plans, the pensioner enjoys more freedom and responsibility as the investment decisions made by the employee become critical in the retirement benefits that they are eligible for.
There are also options wherein the employer or sponsor ensures that the investments made are professionally managed. This ensures a balanced investment portfolio with high expected rates of return.
Advantages for Employees
From the point of view of the employee (or pensioner), the most valuable aspect of a variable-benefit plan is that employees are eligible to receive an annuity that functions like a set monthly income. It is different from a lump sum amount received under a traditional defined-benefit plan or even a cash balance plan.
In addition, variable-benefits plans offer employees a tax-efficient way to invest in the stock market. Since stock market investors only pay capital gains tax when they convert their holdings into cash, an employee with a variable-benefit plan can invest a large share of his income in the stock market through his pension and reduce his total tax liability. The employee will pay less income tax now and also will be better placed to manage his future tax liability.
Advantages for Employers
From the perspective of the employee (or sponsor), it is more convenient to opt for a variable-benefit plan. This is because such plans eliminate the traditional risks that may be associated with defined-benefit plans.
Variable-benefit plans enable a company’s management to determine the stable cost of contribution to retirement benefits. It enables them to select a policy that is better suited to the long-term goals of the company.
Related Readings
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional CFI resources will be very helpful:
