What does amortization mean in the context of a pension plan?


There are two main amortization needs in the context of a corporate pension plan. The first example could include a company determining whether to retroactively apply current or new pension benefits to employees who rendered services prior to the implementation of the current iteration of the pension plan.

The second type of amortization applies to the carry forward of current gains or losses in the retirement account resulting either from experience different from what had been assumed or from changes in actuarial assumptions.

Amortization of the cost of previous services

When a pension plan provider decides to implement or change a plan, covered employees almost always receive credit for any qualifying work performed prior to the change. The extent to which past work is covered varies from plan to plan. When applied in this way, the plan provider must retroactively cover this cost for each employee fairly and equally over their remaining years of service.

Although the word “amortization” is almost always applied to loan payments (like an amortization schedule for a mortgage loan), the concept of amortization really only means smoothing financial numbers over a period of time. For past service costs, depreciation is an accounting technique used to allocate costs over time that might otherwise compromise current cash flows or financial reports.

Amortization of actuarial gains and losses

Accounting for pension plans requires providers to estimate the expected return on plan assets. Whenever there are discrepancies between actual and expected returns, and often are, the plan provider must report them as a gain or a loss.

There are several ways to estimate expected returns. If a company switches from one valuation method to another, the changes should be recognized in the net cost of periodic services and should be applied consistently from year to year for each asset class. Accountants amortize these gains and losses to ensure consistent application.


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