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Median net worth changes over time

with the normal pattern being that net

worth increases with age.

P spouses as well. A defined benefit plan is often
erhaps the most ubiquitous measure of
referred to as a pension.
financial health is net worth, and despite
its conceptual simplicity, it is often poorly
In defined benefit plans, employers bear all the
understood by those lacking a background in risk associated with the fund’s adequacy because
finance. Two of the easiest mistakes made when the employer must pay the prescribed pension
calculating net worth are (1) the improper valua- income to each retiree regardless of the accumu-
tion of future income from pensions and (2) the lated size of the fund. Because of the risk and the
improper comparison of personal net worth with fact that defined benefit plans are more expensive,
published figures, such as national averages. Mak- employers have been shifting away from defined About the
ing either mistake can lead to unnecessary anxiety benefit plans toward defined contribution plans. authors
about retirement. Charles R. Pryor,
INCLUDING RETIREMENT PLANS IN NET-WORTH
RETIREMENT PLANS CALCULATIONS Ph.D., is a professor
of accountancy,
A retirement plan is a contractual arrangement A person’s net worth is equal to his or her assets
and Stephen S.
obligating an employer to provide retirement ben- minus his or her liabilities. Net worth can be
Gray, DBA, is an
efits to employees. Although there is considerable positive or negative. It fluctuates over time, and
assistant professor
variability in their structures, features, and benefits, properly understood, it provides a good snapshot of
of finance, both
most employer-sponsored retirement plans can be financial health at a point in time. There are many
at Western Illinois
described as either defined contribution plans or types of assets, and they all increase net worth, but
University in
defined benefit plans. some tend to have larger effects than others. For
Macomb, Ill.
most people, one of the largest and most important
Defined contribution plans components of their net worth is their retirement Nicholas C. Lynch,
Ph.D., is a professor
Defined contribution plans are employer-sponsored plan.
of accountancy
retirement plans with accounts maintained sepa- at California State
rately for each participating employee. Some types Defined contribution plans’ effect on net worth is University–Chico
of defined contribution plans allow the employee easily calculated
in Chico, Calif.
and the employer to contribute to the employee’s With a defined contribution plan, the retiree’s
account (e.g., 401(k) and SIMPLE plans), and future income stream is the unknown. Income will
some allow only employer contributions (e.g., depend on making reasonable withdrawals from the
SEPs). retirement savings account where reasonableness
is based on the account balance at retirement, the
Defined benefit plans expected rate of return on the invested funds, and
A defined benefit plan is just what it sounds like; the life expectancy of the retiree.
the benefit to the retiree is defined by the terms The important thing to note for retirement
of the plan. Although some plans with defined planning is that the value of a defined contribution
benefits, such as cash balance plans, are actually plan at any point in time is equal to its balance at
hybrids, the majority of defined benefit plans that time. This is because employers are not obli-
obligate the employer to pay a certain amount of gated to provide benefits beyond the contributions
retirement income as an annuity that continues required by the terms of the plan. In other words,
until the employee’s death. In fact, most of these employees bear all the risk that the fund may be
plans include lifetime income support for surviving inadequate to meet their retirement needs, so a

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