How Pension Funds WorkPosted: January 10, 2012
A pension fund is a pool of common assets set up to provide retirement income for the employees of an organization. Such funds are among the largest players in the US financial market they are usually professionally managed. The pensions they provide are benefits designed to make employment at a particular entity more attractive.
Pension plans were originally directly administered by the organization offering the benefit. Today they are often indirectly administered by an outside entity. There are also stand alone pension funds that manage retirement benefits for people in a particular profession in a region. School teachers in a particular state for example.
Defined Benefit Plans
A pension fund generally offers what is called a defined benefit plan. The employer guarantees the employee an amount of income that he or she will receive each month during retirement. The amount is usually but it can be adjusted for inflation which means the payment rises with the cost of living index.
To fund these payments money is put into a fund. Professional managers then invest that money to ensure that there will be enough cash available to cover investments in the future. These funds are usually invested in the stock and bond markets in order to compensate for inflation and future demands.
In most of these plans the funds invested are a combination of deductions from employee salaries and contributions from the employer. Such plans were once the norm but they are rarely offered in the private sector today.
Drawbacks to Pension Funds
The main drawback to a pension fund is that it is usually managed directly by the company or agency that created it. The problem with this is that the management of the company can raid the fund and use the money in it for other purposes.
For example the management of a company could use the funds to finance expansion or big bonuses for executives. There have been allegations that numerous pension plans have been deliberately looted by corporate management.
Another drawback is that the fund could be poorly managed so it will lose money in the market. There is also the possibility that the pension fund will simply not have enough cash in it to cover all of the pension obligations. Allegations that pension funds for public employees in a number of states were severely under funded have been made for years.
Many public employees’ pension plans are also subject to political pressure. They may refuse to invest in certain stocks such as oil stocks for political reasons. There have also been efforts to stuff the boards that run them with political appointees that have little or no financial knowledge or expertise.
Pension Funds and the Law
Pension funds are regulated by two federal laws the Welfare and Pensions Disclosure Act (which gives the US Department of Labor the power to regulate pensions) and the Employee Retirement Security Act or ERSIA. ERSIA created the Pension Benefit Guarantee Corporation or PBGC. The PBGC partially guarantees private pension plans it will not guarantee government pensions.
Something you should be aware of is that although the PBGC insures pensions it will not pay the whole amount. Wiley worked at Acme Corporation for thirty years and received a pension of $500 a month. A few years after Wiley retired Acme went bankrupt leaving the pension fund empty. The PBGC stepped in and took over the benefits. Unfortunately Wiley was now receiving a pension of just $200 a month. Wiley ended up having to go back to work to pay his bills.
Precautions You Can Take
If you are planning to depend on a pension to provide for retirement income there are some step you can take to ensure income. An annuity is tax-deferred and insured and it can provide a stream of regular retirement income. Other options to look into include reverse mortgages and life insurance policies.