Certified Plan Sponsor Professional (CPSP) Practice Exam

Which of the following is a risk specific to Defined Benefit plans?

1. The potential for investment losses

2. The risk of underfunding due to actuarial assumptions

3. The instant changes in tax rates

4. Losses from employees withdrawing early

The correct answer is: The risk of underfunding due to actuarial assumptions

Defined Benefit plans carry specific risks that differ from those associated with other retirement plans, particularly regarding the obligations they have toward participants. The identified risk of underfunding due to actuarial assumptions is particularly relevant to Defined Benefit plans because these plans promise specific benefit amounts to participants at retirement, based on a formula usually incorporating factors such as salary and years of service. Actuarial assumptions involve estimates about future events that impact the liabilities of the plan, such as life expectancy, retirement age, salary increases, and investment returns. If the actual experiences deviate adversely from these assumptions—such as if employees live longer than expected or if salary increases happen more rapidly than projected—the plan can become underfunded. This situation poses a significant risk as it can lead to the plan having insufficient assets to meet its future obligations, requiring additional contributions from the plan sponsor to fulfill these promised benefits. In contrast, while investment losses and early withdrawals of employees can be concerns in retirement plans in general, they do not highlight the unique funding and actuarial risks specifically tied to the promise of defined benefits. Instant changes in tax rates can affect the broader regulatory and fiscal environment, but they are not risks uniquely associated with the structure of Defined Benefit plans themselves.