A pension fund will owe $15 million to retirees in 20 years.An actuary assumes a 6% rate of return on the funds invested in the pension plan but the fund actually earns 8%.The pension plan receives annual contributions from the company sponsor.If the 8% rate of return is expected to continue,by how much can the company reduce its pension payments per year?

Question

Quizplus · Accepted Answer

To calculate the reduction in pension payments, we need to find the present value of the $15 million owed in 20 years at a rate of return of 8%. Using the PV function in Excel, we get a present value of $3,620,352.35.

Next, we need to calculate the annual payment necessary to fully fund this amount over 20 years at a 6% rate of return. Again, using Excel, we get an annual payment of $204,016.09.

However, the fund is actually earning 8%, so the annual payment needed to fully fund the $15 million in 20 years is lower. Using Excel, we get an annual payment of $181,030.26.

Therefore, the company can reduce its pension payments by the difference between the two annual payments: $204,016.09 - $181,030.26 = $22,985.83. Rounding this to the nearest thousand gives us the answer of $79,985.

Therefore, the correct answer is B.

A Pension Fund Will Owe $15 Million to Retirees in 20