Accounting Related To Pension

Introduction

The report will focus on the calculation of the pension amount of an individual graduate student starting his career at the age of 25 years. The pension will be provided from the savings of the student and will act as a source of salary income for the period of 20 years (65 to 85 years). The calculations of the pension are mad e in accordance to section 401 (k) of IRS that allows employees to contribute a portion of their salary to individual accounts.

Manjoo (2012) opined that salary sacrifice is a tax efficient way that can be employed by an individual to make pension contributions as well reduce the amount of taxable income. As per the taxation rules Pension offer tax relief on money paid by the individual as well as tax relief on the amount of returns. Hence it is advi

Apart from individual pension saving scheme the students can also get an offer from the employer to contribute a certain amount of money for the pension scheme. This is known as occupational or company pensions. Menzefricke & Smieliauskas (2012) stated that the major benefit of occupational pension schemes is that the employer as well as the employee both will contribute to the pension fund.

Pension schemes in USA

A retirement plan is effectively a substitute financial arrangement to replace employment income upon retirement. The groups like employers, insurance companies, trade unions and government sets up the effective pensions schemes for the individuals in order to secure funds for the future use purpose (Menzefricke & Smieliauskas, 2012). The retirement and the pension’s plans in USA are based on the regulations provided under the Internal Revenue code which is regulated by the department of Labor under the provisions of the Employee Retirement Income Security Act. The contributions to qualified pensions plans can be made on a pre tax basis. The employees are allowed to transfer a part of their contribution to a 401(k) plan as designated Roth contribution.

The various types of pension system design are namely

Public pensions: The Public pension’s scheme in USA operates on the basis of pay as you go. The public sector pensions are offered by Federal, state and local levels of government in USA. The pensions in this system are financed by social security taxes paid by employers and employees both. Manjoo (2012) opined that social security taxes are shared by equally by employers and employees. As per the US law the contributions in this fund are exempted from any taxation however the benefits are taxed if the total income of pension at the time of retirement exceeds a specified amount then the benefit is taxable. The statutory retirement age of the individual is regarded to be between 65 to 67 years depending upon the year of birth.

Occupational pensions: The occupational pensions are provided by the private companies of USA. The plan used in the occupational pension scheme is the 401 (k) plan under the IAS retirement plans. This plan enables the employees and the employers to make tax deferred contributions from their salaries to the plan (Sandu, 2012). Other plans namely the 403 (b) plan also known as the employer sponsored retirement plan, 457 plan also known as the employee sponsored pension plan and the thrift savings plan are the major plans to be used as pension schemes under this system.

Pension calculation

(a) Working tenure of the student

Graduating age – 25 years (starting of career)

Working career – 40 years

Retirement age – (40+25) = 65 years

The students are expected to retire at the age of 65 years and start the career at the age of 25 years and continue work for 40 years without any breaks.

Salary calculation

The salary calculation is shown on the basis of the assumptions made by the student. However the rate of increment and the expectation of the student to get an increment of $15000 every 10 years due to shifting of the job can vary in the reality. Moreover the inflation rate assumed to be affecting the salary structure of the student will also vary and hence this may reduce the actual salary amount of the student. The inflation rate has been reduced from the annual salary because the inflation will decrease the amount of money earned by an individual.

To calculate the amount of money required for saving each year by the students for contribution towards final retirement scheme two different techniques may be adopted namely Final salary pension scheme or Career average schemes. Sandu (2012) opined that the average of the salary throughout the career of a student is calculated in case of Career average schemes whereas the Final salary pension scheme helps to calculate the amount of money that the individual will receive at the end of final retirement.

Under the Final salary pension scheme the annual pension of the given student under the given salary can be calculated as follows:

Assumptions:

• Final salary at the time of retirement that is at an age of 65years after including and excluding all increments and inflation is around $ 90000.
• The total working tenure of the student is 40years.
• The accrual rate or the percentage of salary expected to receive as pension = 50 % or 1/50^th

Keeping the above factors in calculation the annual expected pension can be calculated as follows:

(40 years * 1/50^th * 90000)

= $ 72000

For an annual pension of $ 72000 the individual will have to save around $ 1800 ($ 72000 / 40) per year within the total working tenure of 40 years.

The students are expecting to have a actuarial life till 85 years after the retirement. Hence it may be said that the individual is expected to have a further life expectancy of (85-65) 20 years after retirement. Thus saving of around $ 1800 per year from the total salary will help the individual to get a capital amount of $ 72000 which will cover the 4% annuity as well as the 50% of the final salary which the individual will receive at the end of his retirement year.

Conclusion

The report shows the calculation of the individual pension fund of a student who is expected to start his career at the age of 25 years. The problem shows that the student will receive a 2% increment every year followed by a 15000 increment every 10 years in the existing salary structure of 50000.Hence saving of $ 1800 each year will help the individual to accumulate an approximate amount of $ 72000 which will act as a pension fund for the student for the next expected 20 years of his life.

References

Manjoo, F. (2012). “The UK legal reforms on pension and the opportunity for Islamic pension funds,”J Islamic Acc And Bus Res, 3(1), pp- 39-56.

Menzefricke, U., & Smieliauskas, W. (2012). “Incorporating Uncertainty into Accounting Estimates of Pension Liabilities,” Rotman International Journal Of Pension Management, 5(1), pp- 26-32.

Sandu, M. (2012). “Economic Consequences of Pension Accounting,” International Business Research, 5(8), pp- 172