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Pension

From Academic Kids

A pension (also known as superannuation) is a retirement plan intended to provide a person with a secure income for life. Although a lottery may provide a pension, the common use of the term is to describe the payments a person receives upon retirement.

Pensions have traditionally been payments made in the form of a guaranteed annuity to a retired or disabled employee, or to a deceased employee's spouse, children or other beneficiary. A pension created by an employer for the benefit of an employee is commonly referred to as an occupational or employer pension. Labor unions, the government, or other organizations may also sponsor pension provision.

Contents

Types of pensions

A "pension plan" or "retirement plan" is an arrangement by which an employer (for example, a corporation, labor union, government agency) provides income to its employees after retirement. Pension plans are a form of "deferred compensation" and became popular in the United States during World War II, when wage freezes prohibited outright increases in workers' pay.

Pension plans can be divided into two broad types: Defined Benefit and Defined Contribution plans. The Defined Benefit plan had been the most popular and common type of pension plan in the United States through the 1980s; since that time, Defined Contribution plans have become the more common type of retirement plan in the United States.

Since the 1990s, "hybrid" pension plans have been formulated. These plans combine characteristics of each of the Defined Benefit and Defined Contribution types. Examples include Cash Balance and Pension Equity plans.

Defined Benefit Plan

The Defined Benefit plan (as its name implies) defines a benefit for an employee upon that employee's retirement. A simple example is a pension plan that provides $100 per month for every year an employee works for a company; with 30 years of employment, that participant would receive $3,000 per month payable for their lifetime. The benefit in a defined benefit pension plan is determined by a formula, which can incorporate the employee's pay, years of employment, age at retirement, and other factors.

The United States Social Security system is an example of a defined benefit pension arrangement, albeit one that is constructed differently than a pension offered by a private employer.

The "cost" of a Defined Benefit plan is not easily calculated, and requires an actuary. So, for this arrangement, the benefit is known but the contribution is unknown (until calculated).

Defined Contribution plan

In a Defined Contribution plan, the contribution is defined, but the benefit is unknown. A typical Defined Contribution arrangement is one under which contributions are made (by the employer, the employee, or both) into an account which grows via investment. At retirement, the employee has an account that can be used to purchase an annuity, or can have amounts withdrawn as the financial need for the employee arises.

A very common type of Defined Contribution plan in the United States is the 401(k) plan, named after the Section of the Internal Revenue Service (http://www.irs.com) Code. Under a 401(k) plan, an employee contributes a portion of that employee's salary into to an account, before taxes are withheld. For example, an employee who receives $1,000 per week might contribute 5% of this amount, or $50. That employee would be taxed (for IRS and Social Security purposes) on only $950. The 401(k) account grows tax-deferred. Often, an employer contributes to the employee's 401(k) plan.

In a defined contribution plan, investment risk and investment rewards are assumed by each individual/employee/retiree and not by the sponsor/employer.

The "cost" of a Defined Contribution plan is readily calculated. But, the benefit from a defined contribution plan depends upon the account balance at the time an employee is looking to use the assets. So, for this arrangement, the contribution is known but the benefit is unknown (until calculated)

Financing

There are various ways in which a pension may be financed.

In a funded Defined Contribution pension, contributions are paid into a fund during an individual's working life. The fund will be invested in assets, such as stocks, bonds and property, and grow in line with the return on these assets.

In an unfunded Defined Contribution pension, no assets are set aside and the benefits are paid for by the employer or other pension sponsor as and when they are paid. Pension arrangements provided by the state in most countries in the world are unfunded, with benefits paid directly from current workers' contributions and taxes. This method of financing is known as Pay-as-you-go. It has been suggested that this model bears a disturbing resemblance to a Ponzi scheme.

In a funded Defined Benefit arrangement, an actuary calculates the contributions that the plan sponsor must make to ensure that the pension fund will meet future payment obligations. This means that in a defined benefit pension, investment risk and investment rewards are typically assumed by the sponsor/employer and not by the individual. If a plan is not well-funded, the plan sponsor may not have the financial resources to continue funding the plan. In the United States, private employers must pay an insurance-type premium to the Pension Benefit Guaranty Corporation (http://www.pbgc.gov), a government agency whose role is to encourage the continuation and maintenance of voluntary private pension plans, provide timely and uninterrupted payment of pension benefits.

A growing challenge for many nations is population ageing. As birth rates drop and life expectancy increases and ever larger portion of the population is elderly. This leaves fewer workers for each retired person. In almost all developed countries this means that the pension system will eventually go broke unless reformed. The three exceptions are Australia, Canada, and the United Kingdom where the pension system will be solvent for the foreseeable future. In Canada, for instance, the annual payments were increased by some 70% in 1998 to achieve this. These three nations also have an advantage from their relative openness to immigration.

History of pensions in the United States

  • 1963: Studebaker terminated its pension plan, leaving employees with no legal recourse for their pension promises.
  • By the 1970s: Independent stock analysts' (called fiduciaries) are required to make pension-fund investments pay up for their pension beneficiaries. State laws prevent fiduciaries from favoring any company or taking big risks. If fiduciaries lose money on pension investments, they can be sued for malpractice. This scared away banks, which wouldn't handle pensions. Small businesses opened for managing pension funds.

Pension systems in various countries

See also

External links

Agencies

Articles

he:גמלאות nl:Pensioen ja:年金 fi:Elke

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