What is the Benefit Allocation Method?
The benefit allocation method refers to a way through which companies fund an employee pension plan. For each year, only one premium payment is made and it’s utilized to buy a single benefit. Usually, the plan states that for each unit of service, a specific amount would be received by the employee, either a stated salary percentage of a dollar amount, towards an employee pension.
The details for the benefit allocation method of each company are likely included in the employee benefit plan of the company. The benefits are determined by the average of an employee’s salary in the long run. Employees who get highly compensated get more benefits solely because they have made more payments into the system. Typically, the transaction involves purchasing an annuity.
Employees who are higher paid, having longer service usually get a greater benefit. For each year of service, payments are made to the employer. Notable for companies is the fact that their method of benefit allocation should put into consideration that the costs associated with future years might align to increase continuously for specific segments of their employee population. For instance, individuals getting close to retirement age as they plan on leaving the company. Increases are as a result of the ever-shortening period within which interest is capable of compounding.
Also, it can be magnified by the method of benefit allocation utilized by the company, and by the reduced possibility of terminating an employee before retirement. On the other hand, for most plans, membership is open and there is a continuous joining of new members. Maintaining a balance is key. Provided the employee population’s average age is stabilized as new members join, and the younger ones balance the advancing ages of older employees getting closer to retirement, rates of contribution can remain consistent. All things being equal, benefit allocation methods usually lead to lower funding levels as against equivalent cost allocation methods.
There is a difference between cost allocation methods and benefit allocation methods because they check the total benefit costs, however, accrued, as an amount to have equal allocations to all service years. For instance, the aggregate level cost methodology usually takes the present benefit value minus asset value and then spreads the surplus amount over the future participants’ payroll. Aggregate cost methods, among others, consider the whole group and usually, the cost of the plan is calculated as a yearly payroll percentage. Also, the percent is adjusted each year in a situation where actuarial gains or losses exist.
