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What Factors Affect the Present Value of Pensions?

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  • Written By: K. Kinsella
  • Edited By: Shereen Skola
  • Last Modified Date: 04 September 2016
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Pensions come in many varieties although these plans are normally categorized as either defined contribution or defined benefit plans. The present value of pensions depends in part upon the performance of the underlying securities such as stocks, bonds, certificates of deposits and mutual fund shares. Defined benefit plan values are also impacted by different riders that assure the account of holder of varying levels of payouts at different points in time. Consequently, many pension plans include both an insurance value and a cash value; these two values are seldom the same.

Defined contribution plans are pensions into which an individual or entity makes regularly scheduled deposits. Typically, the account owner cannot access the funds prior to retirement age but at that time will receive a sum of money that is equal to the present value of the account's holdings. In most instances, defined contribution plans contain mutual fund shares and fixed interest securities such as certificates of deposit (CDs). Mutual fund shares fluctuate on a daily basis since these funds actually invest in other securities such as stocks and bonds, while CDs typically have principal protections; CD account holders can lose money on these products due to early redemption penalties. With defined contribution plans, the present value of pensions reflects the current market value of the underlying securities after adjustments have been made to account for any redemption penalties.

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With a defined benefit plan, the account holder's contributions are normally invested in annuities. The firm that issues the annuity normally agrees to pay the account holder a lump sum of money on a specified future date. Even if the annuity contract loses money over the course of time, the present value of pensions containing annuities often has more to do with the annuity contract guarantees than the current worth of the securities that the plan contains.

In some instances, defined benefit plan participants decide to make withdrawals prior to the plan maturity date. When this occurs, the participant receives the greater of the cash value or the insurance value. The cash value represents the present value of pensions, whereas the insurance value represents an amount of money that the plan operator promises to pay to the plan participant in the event of an early withdrawal. Insurance withdrawal values are often adjusted to account for administrative fees and penalties. Pension plan operators assess annual fees for these insurance riders and these costs further deplete the present value of pensions.

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