Academic journal article Journal of Legal Economics

The Valuation of the Loss of Future Pension Income

Academic journal article Journal of Legal Economics

The Valuation of the Loss of Future Pension Income

Article excerpt

Introduction

In employment termination, personal injury, or wrongful death cases, economists often need to compute not only the loss of a stream of earnings during the potential employment years but also the loss of future pension benefits.

Forensic economists differ in the specific methodology that they use to calculate the future loss of earnings. While they use different work life tables and different discount rates, there is some general consistency in the valuation, at least in terms of the timing of the loss. The same is not necessarily true with the valuation of lost pension income, especially if the loss is of a defined benefit pension. Having examined numerous reports by forensic economists, I find little consistency in the methodology applied to the calculations of these pension losses. The primary purpose of this paper is to discuss the proper actuarial methodology for the calculation of these losses.

The first substantive section of the paper is devoted to a taxonomy of pensions, defining various types and sub-types of pensions. The second section is devoted to the discussion of the proper actuarial methodology for the calculation of the lost pension benefits. The third section is devoted to a discussion of additional variables that need to be considered in pension loss calculations. The most important of these variables has to do with tax consequences of lost pension which are most applicable for FELA or Jones Act cases and for the calculation of tax neutralization in employment cases.

Pension Taxonomy

There are basically two major types of pension plans: defined contribution plans and defined benefit plans.

Defined Contribution Plans

If the pension plan defines the contribution that the employer would make into a designated account for the employee, it is a defined contribution plan. The account which would typically accrue interest or investment gain (or loss) will be made available upon retirement from employment and may be taken out by the employee in a single lump sum. Most plans offer the option of converting the lump sum available at the time of retirement into an annuity for the employee's life time. Examples of defined contribution plans are 401K plans, IRA-SEP plans, and profit sharing plans.

Defined contribution plans are most popular with business enterprises. In the past 20 to 30 years, these plans have become very popular. Many unions have also adopted such plans in addition to the traditional defined benefit plans that they have.

Defined Benefit Plans

If the pension plan defines the benefit that the employee would receive upon retirement from employment, it is a defined benefit plan. The plan typically defines the formula that will be applied to compute the monthly retirement amount that the employee would receive at retirement. The benefit amount usually depends on the age of the person at retirement, the number of years of credited service, and the average salary of the individual during some period near retirement. Almost all governments, most unions, and many corporations have defined benefit plans.

A special category of defined benefit plans are known as cash balance plans. These plans are created when a company switches from a defined benefit into a defined contribution plan. In that case, the company computes the actuarial present value of the defined benefits that were accrued to each employee as of the date of conversion, and places that amount of cash in the account of each employee.

Contributory and Noncontributory Plans

A plan is said to be a contributory plan when the employee is required during the employment years to contribute funds into the plan. A plan is said to be a noncontributoryplan when the employee does not have to contribute into the plan.

In contributory defined benefit plans, the employee contributions may be tracked by the plan, and a statement is issued periodically as to the amount of the accumulated contributions. …

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