Aggregate Level Cost Method

  

The aggregate level cost method represents a way to figure out the finances of a pension plan. It estimates the costs and benefits that will likely be associated with the plan over the course of its life.

Rather than making the calculations on a person-by-person basis, this process looks at all the people in the plan as a bundle. That's why it's called "aggregate level"; it's looking at things in aggregate, or in total, rather than piece by piece. The goal here is to try and ameliorate sketchy marketing claims that a fund is ‘super low cost' when, in reality, with all kinds of hidden fees...it ain't.

Related or Semi-related Video

Finance: What are Pension Liabilities?23 Views

00:00

finance a la shmoop. what are pension liabilities? okay so if you haven't seen

00:08

our James Cameron directed and shmoop academy award-winning video called

00:12

what is a pension, we'll watch that first. before you continue. okay hi welcome back. [link to pension video]

00:20

a pension liability is not that different from a liability owed by any

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corporation or even an individual. the corporations and governments both

00:30

provide pensions for their employees. very roughly an employee making say 75

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grand a year might get 10% of a salary a year in pension contributions from the

00:41

employer. while pensions are divided into two

00:43

flavors. there are defined contribution pensions - one flavor of a 401k plan. in a

00:49

defined contribution plan the employee contributes say 10% of their salary and [defined contribution pension defined]

00:55

in this case that would be 7,500 bucks. and the employer might match it. that is

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the employer takes 7,500 bucks off of their total salary that is calculated

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for taxes so the employee instead of being taxed on 75 grand a year gets

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taxed on sixty seven thousand five hundred they then defer the 7,500 bucks

01:13

they put into their 401k plan and well they'll still pay taxes on it eventually [equations on screen]

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when they take it out but presumably when they're old and retired and poor

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and thus likely to pay lower tax rates than they would in their heavy working

01:28

high tax hike tax rate era at the peak of their careers. so the employee saves

01:32

seventy five hundred bucks there or at least puts it away, and the employer

01:36

matches that 75 with seventy five hundred of its own. so from the employers

01:40

perspective that employee does not just get a seventy-five thousand dollar [equations on screen]

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salary they cost the employer 75 grand plus another seventy five hundred bucks

01:50

of 401k pension matching expenses or eighty two thousand five hundred dollars.

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and the employer pays it grumbling and wondering when the next version of robot

01:59

comes out so they can replace this worker ,well what happens to those

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savings. well, employers usually provide employees with a menu of investment

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choices they can hold all cash, they can invest in high-growth relatively risky [list of investment options shown]

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funds, they can invest in balanced growth and income funds and so on and so on.

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well the employee gets to choose from a supermarket of investment fund choices

02:20

or even buy individual stocks in their pension. the key takeaway at the

02:24

end of however many years or decades of working the employee is able to take out

02:29

from their pension whatever value that pension has accrued to be worth over

02:34

that time period. easy. in a defined contribution fund there is essentially [flow chart]

02:39

no pension liability. no pension liability to the corporation other than

02:45

each year doing the matching thing on that salary. okay?

02:48

the employee bears the stock market risk just like everyone else. the big

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controversies you read about in the press revolve around the benefit flavor

02:56

of a pension, 2nd flavor here, called a defined benefit plan. in a defined

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benefit situation a number of irresponsible financial dealings take [types of pensions listed]

03:07

place where taxpayer money is often just given away with no thought of fiduciary

03:13

duty or obligation to ,you know being respectful of the taxpayers hard-earned

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money. a given government worker works for the state for 30 years eventually

03:22

making a hundred grand a year at the end having received pension contributions

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all along the way just as in the defined contribution system that corporations [equation on screen]

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use as outlined above .only in a government defined benefit program the

03:36

employee is guaranteed a minimum rate of return in many situations. that is the

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employee is guaranteed say 10% a year in investment returns even if the stock

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market is flat or down or bad for 7 ,10 15 ,years whatever. that happens all the

03:53

time, yet the taxpayers on the hook to give

03:56

them that guaranteed 10 percent a year compound rate. well at a 10 percent of [flow chart]

04:00

your compound rate after seven years well let's say the actual stock market

04:05

return was only 7 percent and the employee lagged 3 percent a year each

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year compounded well that would be a lot that the state would then owe them so

04:15

that's one flavor of pension liability that could likely bankrupt California

04:20

and Illinois at some point not too far away because the pension liabilities [California and Illinois pictured.]

04:24

there are enormous. and it gets worse there are other irresponsible things the

04:28

states have done like guarantee retirement return minimums or investing

04:32

pension money in dead stock beanie babies. it was a really bad investment by

04:37

CalPERS there huh. so yeah pension liabilities are a

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totally simple easy to understand uncontroversial thing and while they

04:44

can't possibly have an adverse effect on the world around us right? sorry hard to

04:49

keep a straight face there. [man talks out the side of his mouth]

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