The actuarial cost method is used by actuaries to determine the amount of periodic payments that an employer must make into a pension plan. The outcome of using this method is a payment figure that, when combined with the return on investment on funds already invested, offsets the amount of payments made from the plan. The goal of the actuarial cost method can be achieved by using either of the following two approaches:
Cost approach. Calculates the estimated total benefit to be paid out and then works backwards to determine the total periodic cost required to meet the projected benefit.
Benefit approach. Calculates the amount of benefit associated with employees’ service to date and uses a discount factor to reduce this benefit to its present value.