Funded Pension Scheme: In Depth
A funded pension scheme refers to a retirement plan where pension benefits are paid out from a dedicated pension fund. This fund is actively managed and invested in various securities, aiming to grow over time and produce the returns necessary to meet future pension liabilities. The primary goal of a funded pension scheme is to accumulate a large enough corpus through investments so that it can sustainably pay out retirement benefits to its members.
In contrast to a pay-as-you-go (PAYG) pension system, where current workers’ contributions are used to pay current retirees’ benefits, a funded pension scheme relies on a pool of funds that grows through investment returns. This characteristic makes funded pension schemes particularly reliant on investment performance and financial market conditions.
Key Components
- Pension Fund: The core of a funded pension scheme, this fund is made up of contributions from employees and employers, which are invested in stocks, bonds, and other securities.
- Investment Management: Professional fund managers oversee the investment and growth of the pension fund, making strategic decisions to maximize returns.
- Pension Benefits: Retirees receive regular pension payments from the accumulated fund, ensuring they have ongoing income in retirement.
Examples of Funded Pension Schemes
- 401(k) Plans: In the United States, many employers offer 401(k) plans as a means of saving for retirement. These plans typically include employer matching contributions and are invested in a variety of financial instruments.
- Superannuation Funds: In Australia, superannuation funds are compulsory for employees and operate as funded pension schemes, where contributions are invested for long-term growth.
- Defined Benefit Plans: These traditional pension plans promise a specific retirement benefit amount, which is often guaranteed and paid from a funded pension pool.
Frequently Asked Questions
Q1: What is the main advantage of a funded pension scheme? A1: The main advantage of a funded pension scheme is the potential for the pension fund to grow through investments, providing robust and potentially higher retirement benefits compared to unfunded schemes.
Q2: How does a funded pension scheme differ from a pay-as-you-go system? A2: A funded pension scheme uses accumulated and invested funds to pay out benefits, while a pay-as-you-go system relies on current workers’ contributions to fund current retirees’ benefits.
Q3: Who manages the investments in a funded pension scheme? A3: Professional fund managers or investment companies typically manage the investment of a funded pension scheme, making decisions aimed at maximizing returns for the beneficiaries.
Q4: Are 401(k) plans considered funded pension schemes? A4: Yes, 401(k) plans are considered funded pension schemes because they are funded by employee and employer contributions and are invested in various securities.
Q5: Can the value of a funded pension scheme decrease? A5: Yes, since the funds are invested in financial markets, the value of a funded pension scheme can fluctuate based on market conditions, which can potentially impact the pension payouts.
Related Terms
- Defined Benefit Pension Plan: A type of pension plan in which an employer guarantees a specified retirement benefit amount based on salary and years of service.
- Defined Contribution Pension Plan: A retirement plan in which the employer, employee, or both make regular contributions, and the final benefit received depends on the investment’s performance.
- Pay-as-you-go (PAYG) Pension System: A pension system where current workers’ contributions are utilized to pay the pensions of current retirees, with no investment fund.
Online References
- Investopedia: Funded Pension Scheme
- Pensions & Investments: Understanding Funded Pension Schemes
- The Balance: Retirement Funds and How They Work
Suggested Books for Further Studies
- “Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back Under Your Control” by David Blake
- “The Economics of Pensions: Principles, Policies, and International Experience” by Robert L. Clark and Melinda Sandler Morrill
- “Managing Pension and Retirement Plans: A Guide for Employers, Administrators, and Other Fiduciaries” by August J. Baker, Dennis E. Logue, and Jack S. Rader
