The loss of a company funded pension plan can often form a significant component of a person’s total loss of employment income, when performing economic loss calculations.
There are two main different types of employer pension plans:
1) Defined Contribution (DC) plans – Under a DC plan, the amount of the annual contributions to the plan are defined under the pension plan. The contributions are generally based on a percentage of income, such as 5% of earnings. However, they can also be a set amount, such as $5,000 per year. The contributions are invested on the person’s behalf and at retirement the amount in the fund is used to purchase an annuity for the retiree.
2) Defined Benefit (DB) plans – Under a DB plan, the amount of the future pension income the person will receive is defined under the pension plan. The amount is generally determined by formula based on number of years of service to the company and the employee’s average earnings amount at retirement. Contributions to the pension plan are then determined by an actuarial assessment of the amount required to fund the future pension liability.
Each of the above plans can either be funded by the employee, the employer, or both. The person’s loss is based on the lost employer contributions only. The lost pension income funded by the employee is paid out of the employee’s wages and salaries and therefore has already been compensated for when calculating the loss of employment income.
The calculation of a pension loss under a DC plan is generally determined by adding an employer-sponsored benefit to the insured’s annual potential employment income based on the amount that the employer would have contributed to the plan on the employee’s behalf.
The calculation of a pension loss under a DB plan can be done under either of the following methods:
1) Based on the company’s required contribution to the pension plan. - The calculation would be made in essentially the same manner as detailed above for a defined contribution plan (although generally more complicated).
2) By estimating the present value of future lost pension income that the person would have received after retirement. – Under this approach, an estimate would first be made of the annual pension that the employee would have received, but for the accident, based on the pension formula. As noted above, the pension formula is generally based on years of service and earnings at the time of retirement. Next an estimate will need to be made of what the person’s annual pension will now be, given the accident. We note that this amount may already be calculated and provided on the employee’s annual pension statement. The difference between the two calculations would represent the annual pension loss. As noted above, only the portion of the pension funded by the employer would be included as a loss. Thus, only one-half of the calculated amount would be claimed when the pension is to be funded evenly by the employee and the employer. Alternatively, the loss could be calculated and then reduced by the amount of saved contributions that the employee would have made to the plan, had he/she continued working.
For DB plans, the first method is generally preferable for younger and middle-aged persons, where there are a number of years to retirement, and the final earnings amount would be difficult to determine. The second method would generally be preferable when the insured was close to retirement at the time of the accident and the relevant amounts required for the calculation can be reasonably estimated.
The calculation of the lost pension benefits under a DB plan can be fairly complicated, and the details of the plan should be reviewed closely. We have seen situations where, as long as the person will continue to qualify for Long-Term Disability benefits, the pension is protected to the point where the person will suffer no (or minimal) loss.
Our Financial Services Advisory Team (FSAT) has significant experience preparing these calculations. In most situations, we are able to estimate the lost pension benefits suffered by the person. However, in complicated situations we will often suggest that the services of a pension expert be obtained to calculate that portion of the person’s economic loss. If you have any questions or require assistance with a calculation, please contact a member of our team.
Article written by: Brent M. Pyper, CPA, CA, CFP