Pension fund
A pension fund, also known as a superannuation fund in some countries, is any program, fund, or scheme which provides retirement income. The U.S. Government's Social Security Trust Fund, which oversees $2.57 trillion in assets, is the world's largest public pension fund. Pension funds typically have large amounts of money to invest and are the major investors in listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold about USD$6 trillion in assets. In 2012, PricewaterhouseCoopers estimated that pension funds worldwide hold over $33.9 trillion in assets, the largest for any category of institutional investor ahead of mutual funds, insurance companies, currency reserves, sovereign wealth funds, hedge funds, or private equity.
Classifications
Open vs. closed pension fund
Open pension funds support at least one pension plan with no restriction on membership while closed pension funds support only pension plans that are limited to certain employees. Closed pension funds are further subclassified into:- Single employer pension funds
- Multi-employer pension funds
- Related member pension funds
- Individual pension funds
Public vs. private pension funds
Plan design
Defined benefit (DB)
A defined benefit plan promises a formula-based pension. The benefit is specified in advance, and the plan sponsor is responsible for ensuring sufficient funding to meet the promise. In DB schemes, investment and longevity risks largely remain with the sponsor.Defined contribution (DC)
A defined contribution plan specifies the contributions paid into an individual account; the eventual benefit depends on contributions and investment returns rather than a pre-set formula. In DC schemes, investment and longevity risks are typically borne by the member. "Money purchase" plans are a canonical DC form.Differences between DB and DC
DB and DC plans differ primarily in the promise, the risk bearer, and portability and funding mechanics. These distinctions underpin regulatory and policy debates tracked in international monitoring such as OECD Pensions at a Glance.Accompanying insurance within pension funds
Occupational and personal pension plans frequently bundle or administer ancillary risk benefits that insure members and their dependants against contingencies other than old age. Supervisory guidance notes that, in addition to a retirement objective, plans may provide disability, sickness, and survivors' benefits.Death benefits
Many plans include death-in-service cover, paying a lump sum or a survivors' pension to a spouse, partner, or dependants. UK regulatory guidance recognizes schemes that provide lump-sum death benefits and the option to establish separate "group life only" schemes for this purpose.The tax treatment of death benefits and unspent pension balances varies by jurisdiction and over time; for example, the UK has announced that most unused pension funds and certain death benefits will fall within the deceased's estate for inheritance tax from 6 April 2027.
Survivors' pensions and spousal protections
In systems governed by ERISA in the United States, the default form of benefit for married participants in many employer plans is a Qualified Joint and Survivor Annuity, which continues payments over both lifetimes. A Qualified Preretirement Survivor Annuity protects the spouse if the participant dies before retirement. The U.S. Internal Revenue Service specifies that QJSA survivor percentages typically range from 50% to 100% of the participant's annuity.Plan terms and local law determine eligibility of non-marital partners. Some employers extend survivor options to domestic partners as a matter of policy even when not legally required.
Disability and ill-health benefits
Pension funds may provide disability pensions or permit ill-health early retirement, often defined with reference to an inability to perform suitable work. U.S. law permits "qualified disability benefits" within pension plans, although detailed regulation differs between DB and DC contexts.Some arrangements include a waiver of contributions/premiums during qualifying disability so that accruals or insurance cover continue while the member is unable to work. Such waiver provisions are common in group life or rider form.
How they work
It is important to distinguish between pension plan, funds and firm. A pension plan is a benefits program set up and sustained by an employer or an employee group. They are managed by state or private firms as well as pension funds. Pension funds are financial mechanisms that provide retirement income for employees after their working life. They work by accumulating contributions from employers, and sometimes employees, which are then invested to grow over time. Upon retirement, employees receive benefits, typically calculated as a percentage of their average salary during their working years. For instance, consider a scenario where a pension scheme offers a payment equivalent to 1% of an individual's average salary over the last five years of their employment for each year they served with the employer. Thus, if an employee worked for 35 years at the company and had an average final salary of $60,000, they would be entitled to an annual pension of $21,000. It is important to point out that one cannot usually take early withdrawals or loans from pensions. Public sector pensions, like the California Public Employees' Retirement System, often include cost-of-living escalators and can be more generous than private sector pensions. Private pension plans are regulated by federal laws such as the Employee Retirement Income Security Act and are insured by the Pension Benefit Guaranty Corporation, which guarantees benefits if a pension plan fails.How pension funds invest their money
Pension funds can make investments into stocks, bond, real estate, and other assets. However, they have to be prudently managed compared to other types of funds due to their lower risk tolerance. For many years, they mainly invest into stable stocks and bond. In order to keep high returns, with changing market conditions, they started to invest into other assets. As of 2023, many pension funds are moving away from managing active stock portfolios towards passive investment methods, focusing on index funds and exchange-traded funds that replicate market indices. Additionally, there's an increasing trend to diversify into alternative assets like commodities, high-yield bonds, hedge funds, and real estate. Newer investment tools for pension funds include asset-backed securities, such as those tied to student loans or credit card debt, which are used to boost returns. Investing in private equity is also rising in popularity; these are long-term investments in non-public companies, aimed at achieving substantial profits through eventual sales when these companies reach maturity. Furthermore, real estate investment trusts are becoming a frequent choice for pension funds due to their passive investment approach in the real estate sector. Direct investments in commercial properties like office buildings, warehouses, and industrial parks are also prevalent.Many governments around the world have established public pension systems that are partially or fully funded by investments rather than relying solely on payroll taxes. This approach helps to ensure the long-term solvency of these pension programs. Some examples of governments that use pension fund investments are:
- Australia: The Australian Government's Future Fund was established in 2006 to help cover the government's superannuation liabilities. It invests in a range of asset classes, including equities, fixed income, and alternative investments, to grow the fund's assets over time.
- Canada: The Canada Pension Plan Investment Board manages the investment of the Canada Pension Plan's assets. It invests in a diversified portfolio of stocks, bonds, real estate, and other assets to generate returns and secure the future of the public pension system.
- Norway: The Norwegian Government Pension Fund Global, also known as the Oil Fund, is one of the largest sovereign wealth funds in the world. It invests the surplus revenues from Norway's oil and gas industry to help finance the country's public pension system and other government expenses.
- Singapore: The Central Provident Fund in Singapore is a compulsory social security savings plan that requires contributions from both employers and employees. The CPF board invests these funds to generate returns and ensure the long-term financial stability of the pension system.
- Sweden: The Swedish Pension System has a buffer fund, the AP Funds, that invests in various financial instruments to supplement the pay-as-you-go pension contributions and ensure the system's long-term sustainability.