Pension

A pension is a steady income paid to a person (usually after retirement). Pensions are typically payments made in the form of a guaranteed annuityto a retired or disabled employee. Some retirement plan(or superannuation) designs accumulate a cash balance (through a variety of mechanisms) that a retiree can draw upon at retirement, rather than promising annuity payments. These are often also called pensions. In either case, 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.

Occupational pensions are a form of deferred compensation, usually advantageous to employee and employer for taxreasons. Many pensions also contain an insuranceaspect, since they often will pay benefits to survivors or disabled beneficiaries, while annuity income insures against the riskof longevity.

While other vehicles (certain lotterypayouts, for example, or an annuity) may provide a similar stream of payments, the common use of the term pension is to describe the payments a person receives upon retirement, usually under pre-determined legal and/or contractual terms.

Types of pensions

Pension plan or retirement plan

By such an arrangement 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 and many other western countries.

Some plan designs combine characteristics of defined benefit and defined contribution types, and are often known as "hybrid" plans. Such plan designs have become increasingly popular in the US since the 1990s. Examples include Cash Balance and Pension Equity plans.

Defined benefit plans

The typical defined benefit plan(as its name implies) defines a benefit for an employee upon that employee's retirement. 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. A simple example is a flat dollar plan design 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. Typical plans in the United States are final average plans where the average salary over the last three or five years of an employees' career determines the pension; in the United Kingdom, benefits are often indexed for inflation. Formulas can also integrate with public Social securityplan provisions and provide incentives for early retirement (or continued work).

Traditional defined benefit plan designs (because of their typically flat accrual rate and the decreasing time for interest discounting as people get closer to retirement age) tend to exhibit an S-shaped accrual pattern of benefits, where the present value of benefits grows quite slowly early in an employees' career and accelerates significantly in mid-career. Defined benefit pensions are usually not portable - accrued benefits in defined benefit plans are typically payable only at retirement - even when the employee has a vested interest in the benefit. However, if he employer amends the plan documentto allow a lump sum cash benefit at termination, it would be just as portable as defined contribution plans, but this has not been industry practice for all but the cash balance planversion of defined benefit plans. On the other hand, defined benefit plans typically pay their benefits as an annuity, so retirees do not bear the risk of outliving their retirement income.

The United States Social Securitysystem is similar to 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 actuaryor actuarial software. However, even with the best of tools, the cost of a defined benefit plan will always be an estimate based on economic and financial assumptions. These assumptions include the average retirement age and life span of the employees, the returns earned by the pension plan's investments and any additional taxes or levies, such as those required by the Pension Benefit Guaranty Corporationin the U.S. So, for this arrangement, the benefit is known but the contribution is unknown even when calculated by a professional.

It is common for regulations, tax law and accounting standards for all plans that are not Defined Contribution to be regarded as Defined Benefit, so term Defined Benefit is ofted understood to include various types of "hybrid" plans. For example, in the United States, by statute all pension plans that are not defined contribution plans (see 26 U.S.C. § 414(j)" For purposes of this part, the term ?defined benefit plan? means any plan which is not a defined contribution plan. ") are defined benefit plans. This means that the Internal Revenue Code places hybrid plans within the defined benefit ambit.

Defined contribution plans

In the United States, a defined contribution plan is generally defined as a plan providing for an individual account for each participant, and for benefits based solely on the amount contributed to the account, plus or minus income, gains, expenses and losses allocated to the account (see 26 U.S.C. § 414(i)). Plan contributions are paid into an individual account for each member. The contributions are invested, for example in the stock market, and the returns on the investment (which may be positive or negative) are credited to the individual's account. On retirement, the member's account is used to provide retirement benefits, often through the purchase of an annuitywhich provides a regular income. Defined contribution plans have become more widespread all over the world in recent years, and are now the dominant form of plan in the private sector in many countries. For example, the number of defined benefit plans in the US has been steadily declining, as more and more employers see the large pension contributions as a large expense that they can avoid by disbanding the plan and instead offering a defined contribution plan.

Examples of defined contribution plans in the United States include Individual Retirement Accounts(IRAs) and 401(k) plans. In such plans, the employee is responsible, to one degree or another, for selecting the types of investmentstoward which the funds in the retirement plan are allocated. This may range from choosing one of a small number of pre-determined mutual fundsto selecting individual stocksor other securities. Most self-directed retirement plans are characterized by certain tax advantages, and some provide for a portion of the employee's contributions to be matched by the employer. In exchange, the funds in such plans may not be withdrawn by the investor prior to reaching a certain age--typically the year the employee reaches 59.5 years old--(with a small number of exceptions) without incurring a substantial penalty.

Money contributed can either be from employee salary deferral or from employer contributions or matching. Defined contribution plans are subject to IRS limits on how much can be contributed, known as the section 415 limit. The total deferral amount including the employee and employer contribution is the lesser of $40,000 or 100% of compensation. The employee only amount is $13,000 for 2004 with a $3,000 catch up. These amounts increase in 2005 (to $14,000 and $4,000) and 2006 (to $15,000 and $5,000).

The portability of defined contribution pensions is legally no different from the portability of defined benefit plans. However, because of the cost of administration and ease of determining the plan sponsor's liability for defined contribution plans (you don't need to pay a actuaryto calculate the lump sum equivalent under Section 417(e) that you do for defined benefit plans) in practice, defined contribution plans have become generally portable.

In a defined contribution plan, investment risk and investment rewards are assumed by each individual/employee/retiree and not by the sponsor/employer. In addition, participants do not typically purchase annuities with their savings upon retirement, and bear the risk of outliving their assets.

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).

Despite the fact that the participant in a defined contribution plan typically has control over investment decisions, the plan sponsor retains a significant degree of fiduciary responsibility over investment of plan assets, including the selection of investment options and administrative providers.

Hybrid and cash balance plans

Hybrid plan designs combine the features of defined benefit and defined contribution plandesigns. In general, they are usually treated as defined benefit plansfor tax, accounting and regulatory purposes. As with defined benefit plans, investment risk in hybrid designs is largely borne by the plan sponsor. As with defined contribution designs, plan benefits are expressed in the terms of a notional account balance, and are usually paid as cash balances upon termination of employment. These features make them more portable than traditional defined benefit plans and perhaps more attractive to a more highly mobile workforce. A typical hybrid design is the Cash Balance Plan, where the employee's notional account balance grows by some defined rate of interest and annual employer contribution.

Financing

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

Funded status

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. (An unfunded defined contribution pension is an oxymoron.)

In an unfunded defined benefit 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 actuarycalculates 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, 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.

Local or universal plans

Because any dollar of savings by any one person in the economy means a dollar of borrowing by another person (all financial assets in the economy net to zero at all times, but real assets do not), any universal system of pensions cannot save in the conventional way. Therefore, if the Unites States were a true autarkic economy, then any universal pension system must be pay as you go because the food, clothes and services that someone aged 25 year today would need in 40 years would be when he is age 65 would be produced 40 years later. Storing money or financial assets today represents current claims on curent production. But a system of prefunding would enable the accounting of such a system to work, given that real savings in the form of capital inmvestments would have made the economy more productive in the future.

However, once we release the assumption of universality by say allowing for foreign investments -- the average age in Mexico is under 16 -- we can perform some pre-funding. The extent of possible pre-funding could be gaged by the current account or trade deficitor surplus.

Current challenges

A growing challenge for many nations is population ageing. As birth rates drop and life expectancyincreases an ever-larger portion of the population is elderly. This leaves fewer workers for each retired person. In almost all developed countries this means that government and public sectorpensions could collapse their economies unless pension systems are reformed or taxesare increased. One method of reforming the pension system is to increase the retirement age. Two exceptions are Australiaand Canada, where the pension system is forecast to be solvent for the foreseeable future. In Canada, for instance, the annual payments were increased by some 70% in 1998 to achieve this. These two nations also have an advantage from their relative openness to immigration. However, their populations are not growing as fast as the U.S., which supplements a high immigration rate with one of the highest birthrates among Western countries. Thus, the population in the U.S. is not aging to the extent as those in Europe, Australia, or Canada.

Another growing challenge is the recent trend of businesses, like an airlinecompany or computer firm, purposely underfunding one their pension funds in order to push the costs onto the federal government. Bradley Belt, executive director of the PBGC (the Pension Benefit Guaranty Corporation, the federal agency that insures private-sector defined-benefit pension plans in the event of bankruptcy), testified before a congressional hearing in October 2004, ?I am particularly concerned with the temptation, and indeed, growing tendency, to use the pension insurance fund as a means to obtain an interest-free and risk-free loan to enable companies to restructure. Unfortunately, the current calculation appears to be that shifting pension liabilities onto other premium payers or potentially taxpayers is the path of least resistance rather than a last resort.?

Pension systems in various countries

• Canada Pension Plan
• Compulsory Superannuation in Australia
• Indian pension system
• Social security (Sweden)
• Retirement plans in the United States
• Social security (United States)
• UK Pension Provision
• Self-invested personal pensions(UK)

Political pensions

This is a type sui generis as it is not awarded on grounds of justice, contract or socio-economic merits, but as a political decision, in order to take a politically significant person (often deemed a potential political danger) out of the picture by paying him or her off, regardless of seniority.

In British colonial history, the term political pensioner applies thus to the following former ruling houses of princely stateswho saw their feudal territories annexed by the HEICbefore it transferred power in British India to the Crown in 1858. Although politically important members could be relocated or exiled, they retained throughout the Raja hereditary right to their former princely rank and titles (in several cases including a gun salute) as well as a monetary "political pension" as a private purse. Only a few years after India's 1947 independence, the nationalist government 'persuaded' most of them to reliquish the annual pension sum on so-called patriotic grounds. For those who continued to receive their payments, the sums were allowed to become a pittance through uncompensated inflation.

• the imperial Mughal Family of Padishahs of Delhi
• its failed Muslim fundamentalist challenger, Tippu Sultan's Mysore-based Khudadadempire
• Angre
• Arcot(the Carnatic)
• Assam(not the whole present state)
• Awadh(Oudh)
• Bengal
• Coorg
• Kolaba
• Kurnool
• Masulipatam
• Murshidabad
• Nagpur
• Punjab's last ruling sikh maharajah Duleep Singh
• Satara
• Surat
• Tanjore

Similar arrangements were often made later by other governments.

See also

• Public debt
• Retirement plan
• Pension Benefit Guaranty Corporation
• ERISA
• Bankruptcy code

Sources and External links

Agencies

• Pension Benefit Guaranty Corporation (PBGC)

Research on Pensions

• Pensions and Capital Stewardship Projectat the Labor and Worklife Program, Harvard Law School
• Know Your Pension

Articles

• Who owns Exxon? We do.
• Pension Newsda:Pension

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It uses material from the http://en.wikipedia.org/wiki/Pension Wikipedia article Pension.