Why Is The Defined Benefit Pension Payments Declining?

Understanding Declining Defined Benefit Pension Payments

Question: I ran a plan that has a defined benefit pension, but the annual amount declines as the client gets older. If it’s a defined benefit, shouldn’t that amount stay constant?

Answer: The annual amount is declining because the pension has indexing turned off. Since all dollar figures in the report are displayed in terms of present value purchasing power, a consistent annual pension payment that is not indexed to inflation loses purchasing power each year as inflation effects accumulate.

The present value purchasing power of a stable annual income stream will decrease by a factor of:[inflation] / (1 + [inflation])where [inflation] is the inflation rate configured for the plan (as a decimal).

For instance, with a 2% inflation rate, the payment will decline in purchasing power by:0.02 / 1.02 ≈ 0.0196 = 1.96% per year.

Keywords:Defined Benefit Pension, Purchasing Power, Inflation Indexing

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