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finance a la shmoop. what are pension liabilities? okay so if you haven't seen

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our James Cameron directed and shmoop academy award-winning video called

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what is a pension, we'll watch that first. before you continue. okay hi welcome back. [link to pension video]

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a pension liability is not that different from a liability owed by any

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corporation or even an individual. the corporations and governments both

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provide pensions for their employees. very roughly an employee making say 75

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grand a year might get 10% of a salary a year in pension contributions from the

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employer. while pensions are divided into two

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flavors. there are defined contribution pensions - one flavor of a 401k plan. in a

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defined contribution plan the employee contributes say 10% of their salary and [defined contribution pension defined]

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in this case that would be 7,500 bucks. and the employer might match it. that is

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the employer takes 7,500 bucks off of their total salary that is calculated

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for taxes so the employee instead of being taxed on 75 grand a year gets

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taxed on sixty seven thousand five hundred they then defer the 7,500 bucks

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they put into their 401k plan and well they'll still pay taxes on it eventually [equations on screen]

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when they take it out but presumably when they're old and retired and poor

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and thus likely to pay lower tax rates than they would in their heavy working

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high tax hike tax rate era at the peak of their careers. so the employee saves

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seventy five hundred bucks there or at least puts it away, and the employer

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matches that 75 with seventy five hundred of its own. so from the employers

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perspective that employee does not just get a seventy-five thousand dollar [equations on screen]

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salary they cost the employer 75 grand plus another seventy five hundred bucks

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of 401k pension matching expenses or eighty two thousand five hundred dollars.

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and the employer pays it grumbling and wondering when the next version of robot

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comes out so they can replace this worker ,well what happens to those

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savings. well, employers usually provide employees with a menu of investment

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choices they can hold all cash, they can invest in high-growth relatively risky [list of investment options shown]

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funds, they can invest in balanced growth and income funds and so on and so on.

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well the employee gets to choose from a supermarket of investment fund choices

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or even buy individual stocks in their pension. the key takeaway at the

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end of however many years or decades of working the employee is able to take out

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from their pension whatever value that pension has accrued to be worth over

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that time period. easy. in a defined contribution fund there is essentially [flow chart]

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no pension liability. no pension liability to the corporation other than

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each year doing the matching thing on that salary. okay?

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the employee bears the stock market risk just like everyone else. the big

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controversies you read about in the press revolve around the benefit flavor

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of a pension, 2nd flavor here, called a defined benefit plan. in a defined

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benefit situation a number of irresponsible financial dealings take [types of pensions listed]

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place where taxpayer money is often just given away with no thought of fiduciary

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duty or obligation to ,you know being respectful of the taxpayers hard-earned

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money. a given government worker works for the state for 30 years eventually

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making a hundred grand a year at the end having received pension contributions

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all along the way just as in the defined contribution system that corporations [equation on screen]

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use as outlined above .only in a government defined benefit program the

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employee is guaranteed a minimum rate of return in many situations. that is the

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employee is guaranteed say 10% a year in investment returns even if the stock

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market is flat or down or bad for 7 ,10 15 ,years whatever. that happens all the

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time, yet the taxpayers on the hook to give

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them that guaranteed 10 percent a year compound rate. well at a 10 percent of [flow chart]

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your compound rate after seven years well let's say the actual stock market

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return was only 7 percent and the employee lagged 3 percent a year each

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year compounded well that would be a lot that the state would then owe them so

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that's one flavor of pension liability that could likely bankrupt California

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and Illinois at some point not too far away because the pension liabilities [California and Illinois pictured.]

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there are enormous. and it gets worse there are other irresponsible things the

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states have done like guarantee retirement return minimums or investing

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pension money in dead stock beanie babies. it was a really bad investment by

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CalPERS there huh. so yeah pension liabilities are a

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totally simple easy to understand uncontroversial thing and while they

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can't possibly have an adverse effect on the world around us right? sorry hard to

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keep a straight face there. [man talks out the side of his mouth]

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