A brief aside into music history before launching into a discussion of pension funding.
In the 1990s, a musical genre known as "alternative" became very popular. It was known as "alternative" because it was guitar-based rock-style music, but in approach and spirit, it set itself apart from the mainstream popular guitar-based rock music that dominated the charts, stuff like Guns N Roses and the pretty-boy hair bands of the day. By the end of the decade, though, the Guns N Roses types had faded from the scene and the only rock music left standing were the alternative bands, with groups like Pearl Jam and REM representing some of the most popular performers in the world. The music was still called alternative, even though it was actually just mainstream rock at that point.
Okay, on to pensions...
The alternative minimum cost method is a way to figure out how much money is needed to fund a pension plan. The name has "alternative" in it, but (like those popular alternative bands of the 1990s) the process actually represents the main proscribed way to make these calculations. In 1974, Congress passed a bill called the Employee Retirement Income Security Act, or ERISA. This put guidelines in place for how pension plans had to be funded. One of the results was that most companies started using the alternative minimum cost method for their calculations.
Basically, this technique uses demographic information to figure out how to fund the pension accounts of individual employees. There are two versions of the method and the pension fund can choose whichever one has the lower cost. Hence the name "alternative minimum cost method." The pension plan is selecting the method with the minimum cost among two alternatives.
The details of the two methods are things only an accountant could love. They involve complicated number crunching and the difference between them relates to the numbers being crunched. Just to give you the names of the two methods, though: there's the actuarial cost method and the accrued cost method.
Related or Semi-related Video
Finance: What is a 401(k)?51 Views
Finance a la shmoop... what is a 401k plan? okay say it with me tax deferred savings
that's it it's really not all that complex for the fancy numbers there all [Complex formula scribbles]
right well when you make money at work you get to defer the tax that you'll pay
on your income or earnings to be paid much later in life and you get to invest
that dough and let it ride tax-free until you take it out of your 401k plan [Money coming out of deferred savings piggy bank]
brokerage account and then at that point well you'll pay ordinary income tax on
your gains well the 401k was a part of the tax code
that was put into motion in the 1980s as the government began to painfully
realize that Social Security wasn't all that secure and that a whole generation
of people who had paid money into Social Security wouldn't get anything back so [People protesting outside the white house]
the government opened the door and made it easy or at least easier for the semi
wealthier masses to save money for their retirement and this was a new idea at
the time a whole new concept like a flying car before then it was mama [Man talking and flying car goes by a window]
corporation who managed the pension money for her employees you know that
sucking off the corporate teat and all that stuff well it fostered a sense of
long-term lifetime loyalty to the company and was all just very you know
IBM like a born in pinstriped blue diapers IBM employee with a hard loyal [Baby boy playing with a flashing rattle]
workforce working away there toiling in the IBM salt mines for 35 years
then retiring at 60 and having smoked a lot dying at age 65 and then that was
all she wrote well that was then this is now it's a different era different
financial pressures so companies don't generally offer pensions today and they
don't generally manage them themselves because the cost of buying real talent
like people who consistently beat the stock market in good times and
bad managing that 401k money is astronomically expensive and generally [Boxing gloves punching the stock market]
speaking corporations can't afford to pay those people nine times whatever
the CEO makes so companies generally contribute some amount of money to a
401k and then they leave it up to the employees to figure out how they want to
invest their retirement savings on their own and that's a good thing most of the
time and you know hopefully it's there when they want to go take it out and
they need the money when they're old and decrepit like like I'm getting...
Up Next
What is ERISA? The Employee Retirement Income Security Act (ERISA) of 1974 essentially codifies all of the rules and laws that pertain to the manag...
What is a pension? Pensions are just retirement plans. Employers provide them and pay into funds as an investment for their employees. Once employe...