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Whar are Pension Funds?

2017-03-11T08:25:32+00:00

The term 'Pension Funds' is included in the Economics edition of the Financial Dictionary. Get yours now on amazon in ebook or paperback format. Read more here...

Pension funds are retirement plans which mandate that an employer must do contributions for the benefit of their employee’s future. They contribute such money into a pool of funds. This pool then becomes invested for the employee’s benefit. All earnings which the investments make accrue to the workers once they reach retirement.

Besides these mandatory contributions, there are pension plans which have components of voluntary contributions. Pension plans can permit workers to contribute a portion of their wages and income into the investment plan to help prepare for their retirement. It is also customary and encouraged for an employer to match some part of the yearly contributions of the employees. The limitations on this amount which they can contribute by matching funds are set by the Internal Revenue Service or IRS.

Two primary kinds of pension funds exist today. With defined benefit plans, the companies promise their staff will obtain a minimum benefit amount when they retire. These kinds of plans deliver the minimum regardless of how poorly the investment pool that underlies the fund actually performs. This means that the employer will be required to make a particular pension payment guarantee for their retired employees in these cases.

There is a formula that determines the precise amount. It is typically built on the combination of years in service and aggregate earnings. In the cases where the pension plan assets are insufficient to pay out the defined and guaranteed minimum benefits, then it is the firm which will have to make up the balance of the minimum payment.

Such employer sponsored pension plans and pension funds in the United States hail from the decade of the 1870s. At their peak in the roaring 1980s, they amounted to a participation rate of almost 50 percent of the total workers in the private sector. Around 90 percent of all public employees as well as approximately 10 percent of the private ones receive the coverage of this kind of defined benefits plan nowadays.

The second type of pension funds are defined contribution plans. With these, the employing company engages in particular set contributions to the retirement plans of their employees. They typically will match to some degree their employees’ contributions to the plan. The ultimate payouts which the staff receive while retired come down to the investment results of the plan. In these cases, the firms which sponsor them do not have additional minimum payout liability after they make their pre-set contributions.

The reason these are so much more popular now is that they prove to be far less costly for employers than do traditional forms of pensions. This is because companies are not backing whatever benefits the funds are unable to produce. More and more private corporations and firms have moved over to this form of plan and have closed out their defined benefit plans. While there are a number of defined contribution plans, the 401(k) plan is the most well-known one. For the benefit of not for profit workers, the equivalent plan turns out to be the 403(b) plan.

When the phrase is utilized, “pension plan” typically refers to these more traditional forms of defined benefit plans. These payouts remain established, controlled, and ultimately funded 100 percent by the sponsoring employer. There are corporations which provide a choice from both plan types. Some will even permit their workers to roll over their 401(k) plan balances to their defined benefit or “pension” plans.

A final version of these is the pay as you go pension plan. Employers set these up themselves. Such plans are entirely funded during the accumulation phase by the workers. They may choose to make either a lump sum contribution (as with an annuity) or regular salary-deducted contributions. Besides these capabilities, such plans prove remarkably similar to other 401(k) plans. One disadvantage to them is that they lack a company matching participation program.

The term 'Pension Funds' is included in the Economics edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.