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A pension (, from
Latin Latin (, or , ) is a classical language A classical language is a language A language is a structured system of communication Communication (from Latin ''communicare'', meaning "to share" or "to be in relation with") is "an appa ...

Latin
''pensiō'', "payment") is a fund into which a sum of money is added during an employee's employment years and from which payments are drawn to support the person's
retirement Retirement is the withdrawal from one's position or occupation or from one's active working life. A person may also semi-retire by reducing work hours or workload. Many people choose to retire when they are old or incapable of doing their job d ...

retirement
from work in the form of periodic payments. A pension may be a "
defined benefit planA defined benefit (DB) pension plan is a type of pension plan in which an employer/sponsor promises a specified pension payment, lump-sum or combination thereof on retirement that is predetermined by a formula based on the employee's earningsEarnin ...
", where a fixed sum is paid regularly to a person, or a "
defined contribution planA defined contribution (DC) plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis. Individual accounts are set up for participants and benefits are based on the amounts credited to these acco ...
", under which a fixed sum is invested that then becomes available at retirement age. Pensions should not be confused with severance pay; the former is usually paid in regular amounts for life after retirement, while the latter is typically paid as a fixed amount after involuntary termination of employment before retirement. The terms "retirement plan" and "superannuation" tend to refer to a pension granted upon retirement of the individual. Retirement plans may be set up by employers, insurance companies, the government, or other institutions such as employer associations or trade unions. Called ''retirement plans'' in the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...

United States
, they are commonly known as ''pension schemes'' in the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain,Usage is mixed. The Guardian' and Telegraph' use Britain as a synonym for the United Kingdom. Some prefer to use Britain as shorth ...

United Kingdom
and
Ireland Ireland ( ; ga, Éire ; Ulster Scots dialect, Ulster-Scots: ) is an island in the Atlantic Ocean, North Atlantic. It is separated from Great Britain to its east by the North Channel (Great Britain and Ireland), North Channel, the Irish Sea ...

Ireland
and ''superannuation plans'' (or ''super'') in
Australia Australia, officially the Commonwealth of Australia, is a Sovereign state, sovereign country comprising the mainland of the Australia (continent), Australian continent, the island of Tasmania, and numerous List of islands of Australia, sma ...
and
New Zealand New Zealand ( mi, Aotearoa ''Aotearoa'' (; commonly pronounced by English English usually refers to: * English language English is a West Germanic languages, West Germanic language first spoken in History of Anglo-Saxon Engl ...

New Zealand
. Retirement pensions are typically in the form of a guaranteed
life annuity A life annuity is an annuity An annuity is a series of payments made at equal intervals.Kellison, Stephen G. (1970). ''The Theory of Interest''. Homewood, Illinois: Richard D. Irwin, Inc. p. 45 Examples of annuities are regular deposits to a sav ...
, thus insuring against the risk of longevity. A pension created by an employer for the benefit of an employee is commonly referred to as an occupational or employer pension.
Labor union A trade union (or a labor union in American English American English (AmE, AE, AmEng, USEng, en-US), sometimes called United States English or U.S. English, is the set of varieties of the English language native to the United States. Cu ...
s, the government, or other organizations may also fund pensions. Occupational pensions are a form of
deferred compensation Deferred compensation is an arrangement in which a portion of an employee's income Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms.Smith's financial ...
, usually advantageous to employee and employer for
tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity In law Law is a system A system is a group of Interaction, interacting or interrelated elements that act accord ...
reasons. Many pensions also contain an additional
insurance Insurance is a means of protection from financial loss. It is a form of risk management Risk management is the identification, evaluation, and prioritization of risk In simple terms, risk is the possibility of something bad happening. ...

insurance
aspect, since they often will pay benefits to survivors or disabled beneficiaries. Other vehicles (certain
lottery A lottery is a form of gambling File:A photo of a gambling stand in Paris.jpg, A gambling stand in Paris Gambling (also known as betting) is the wagering of money or something of Value (economics), value (referred to as "the stakes") on an ...
payouts, for example, or an
annuity An annuity is a series of payments made at equal intervals.Kellison, Stephen G. (1970). ''The Theory of Interest''. Homewood, Illinois: Richard D. Irwin, Inc. p. 45 Examples of annuities are regular deposits to a savings account A savings account ...
) 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 or contractual terms. A recipient of a retirement pension is known as a ''
pensioner A pensioner is a person who receives a pension A pension (, from Latin Latin (, or , ) is a classical language belonging to the Italic languages, Italic branch of the Indo-European languages. Latin was originally spoken in the area around R ...
'' or ''retiree''.


Types of pensions


Employment-based pensions

A retirement plan is an arrangement to provide people with an income during retirement when they are no longer earning a steady income from employment. Often retirement plans require both the employer and employee to contribute money to a fund during their employment in order to receive defined benefits upon retirement. It is a tax deferred savings vehicle that allows for the tax-free accumulation of a fund for later use as a retirement income. Funding can be provided in other ways, such as from labor unions, government agencies, or self-funded schemes. Pension plans are therefore a form of "deferred compensation". A SSAS is a type of employment-based Pension in the UK. The
401(k) In the United States, a 401(k) plan is an employer-sponsored defined-contribution pension A pension (, from Latin Latin (, or , ) is a classical language belonging to the Italic languages, Italic branch of the Indo-European languages. Lat ...
is the iconic self-funded retirement plan that many Americans rely on for much of their retirement income; these sometimes include money from an employer, but are usually mostly or entirely funded by the individual using an elaborate scheme where money from the employee's paycheck is withheld, at their direction, to be contributed by their employer to the employee's plan. This money can be tax-deferred or not, depending on the exact nature of the plan. Some countries also grant pensions to military veterans. Military pensions are overseen by the government; an example of a standing agency is the
United States Department of Veterans Affairs The United States Department of Veterans Affairs (VA) is a Cabinet Cabinet or The Cabinet may refer to: Furniture * Cabinetry, a box-shaped piece of furniture with doors and/or drawers * Display cabinet, a piece of furniture with one or more ...
. ''
Ad hoc Ad hoc is a Latin phrase __NOTOC__ This is a list of Wikipedia articles of Latin phrases and their translation into English. To view all phrases on a single, lengthy document, see: * List of Latin phrases (full) The list also is divided alpha ...

Ad hoc
'' committees may also be formed to investigate specific tasks, such as the U.S.
Commission on Veterans' PensionsThe U.S. President’s Commission on Veterans’ Pensions, commonly known as the Bradley Commission after its chairman General Omar N. Bradley
(commonly known as the "Bradley Commission") in 1955–56. Pensions may extend past the death of the veteran himself, continuing to be paid to the widow.


Social and state pensions

Many countries have created funds for their citizens and residents to provide income when they retire (or in some cases become disabled). Typically this requires payments throughout the citizen's working life in order to qualify for benefits later on. A basic state pension is a "contribution based" benefit, and depends on an individual's contribution history. For examples, see
National Insurance National Insurance (NI) is a fundamental component of the welfare state in the United Kingdom Welfare is a type of government support intended to ensure that members of a society can meet basic human needs such as food and shelter. Social s ...
in the UK, or
Social Security Welfare (or commonly, social welfare) is a type of government support intended to ensure that members of a society can meet basic human needs Maslow's hierarchy of needs is an idea in psychology Psychology is the science of mind and ...
in the United States of America. Many countries have also put in place a "
social pension A social pension (or non-contributory pension) is a stream of payments from state to an individual that starts when someone retires and continues in payment until death. It is a part of a pension system of most developed countries, specifically the ...
". These are regular, tax-funded non-contributory cash transfers paid to older people. Over 80 countries have social pensions. Some are universal benefits, given to all older people regardless of income, assets or employment record. Examples of universal pensions include
New Zealand New Zealand ( mi, Aotearoa ''Aotearoa'' (; commonly pronounced by English English usually refers to: * English language English is a West Germanic languages, West Germanic language first spoken in History of Anglo-Saxon Engl ...

New Zealand
Superannuation and the Basic Retirement Pension of
Mauritius Mauritius ( ; french: Maurice, link=no ; mfe, label=Mauritian Creole Mauritian Creole or Morisien or formerly Morisyen ( mfe, kreol morisien, links=no ) is a French-based creole language spoken in Mauritius Mauritius ( ; french: ...

Mauritius
. Most social pensions, though, are means-tested, such as
Supplemental Security Income Supplemental Security Income (SSI) is a means-tested A means test is a determination of whether an individual or family is eligible for government assistance or welfare Welfare is a type of government support intended to ensure that membe ...
in the United States of America or the "older person's grant" in
South Africa South Africa, officially the Republic of South Africa (RSA), is the southernmost country in Africa. With over 60 million people, it is the world's 23rd-most populous nation and covers an area of . South Africa has three capital citie ...

South Africa
.


Disability pensions

Some pension plans will provide for members in the event they suffer a
disability A disability is any condition that makes it more difficult for a person to do certain activities or effectively interact with the world around them (socially or materially). These conditions, or impairments, may be Cognitive disability, cogn ...

disability
. This may take the form of early entry into a retirement plan for a disabled member below the normal retirement age.


Benefits

Retirement plans may be classified as ''defined benefit'', ''defined contribution'' or ''defined ambition'' / ''target benefit'' according to how the benefits are determined. A defined benefit plan guarantees a certain payout at retirement, according to a fixed formula which usually depends on the member's salary and the number of years' membership in the plan. A defined contribution plan will provide a payout at retirement that is dependent upon the amount of money contributed and the performance of the investment vehicles utilized. Hence, with a defined contribution plan the risk and responsibility lies with the employee that the funding will be sufficient through retirement, whereas with the defined benefit plan the risk and responsibility lies with the employer or plan managers. Some types of retirement plans, such as ''cash balance'' plans, combine features of both defined benefit and defined contribution plans. They are often referred to 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

A Defined Benefit (DB) pension plan is a plan in which workers accrue pension rights during their time at a firm and upon retirement the firm pays them a benefit that is a function of that worker's tenure at the firm and of their earnings. In other words, a DB plan is a plan in which the benefit on retirement is determined by a set formula, rather than depending on investment returns. Government pensions such as
Social Security Welfare (or commonly, social welfare) is a type of government support intended to ensure that members of a society can meet basic human needs Maslow's hierarchy of needs is an idea in psychology Psychology is the science of mind and ...
in the United States are a type of defined benefit pension plan. Traditionally, defined benefit plans for employers have been administered by institutions which exist specifically for that purpose, by large businesses, or, for
government A government is the system or group of people governing an organized community, generally a state State may refer to: Arts, entertainment, and media Literature * ''State Magazine'', a monthly magazine published by the U.S. Departmen ...

government
workers, by the government itself. A traditional form of defined benefit plan is the ''final salary'' plan, under which the pension paid is equal to the number of years worked, multiplied by the member's salary at retirement, multiplied by a factor known as the ''accrual rate''. The final accrued amount is available as a monthly pension or a lump sum, but usually monthly. The benefit in a defined benefit pension plan is determined by a formula that can incorporate the employee's pay, years of employment, age at retirement, and other factors. A simple example is a Dollars Times Service plan design that provides a certain amount per month based on the time an employee works for a company. For example, a plan offering $100 a month per year of service would provide $3,000 per month to a retiree with 30 years of service. While this type of plan is popular among unionized workers, Final Average Pay (FAP) remains the most common type of defined benefit plan offered in the United States. In FAP plans, the average salary over the final years of an employee's career determines the benefit amount. Averaging salary over a number of years means that the calculation is averaging different dollars. For example, if salary is averaged over five years, and retirement is in 2006, then salary in 2001 dollars is averaged with salary in 2002 dollars, etc., with 2001 dollars being worth more than the dollars of succeeding years. The pension is then paid in first year of retirement dollars, in this example 2006 dollars, with the lowest value of any dollars in the calculation. Thus inflation in the salary averaging years has a considerable impact on purchasing power and cost, both being reduced equally by inflation. This effect of inflation can be eliminated by converting salaries in the averaging years to first year of retirement dollars, and then averaging. In the US, specifies a defined benefit plan to be any pension plan that is not a defined contribution plan (see below) where a defined contribution plan is any plan with individual accounts. A traditional pension plan that ''defines'' a ''benefit'' for an employee upon that employee's retirement is a defined benefit plan. In the U.S., corporate defined benefit plans, along with many other types of defined benefit plans, are governed by the Employee Retirement Income Security Act of 1974 (ERISA). In the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain,Usage is mixed. The Guardian' and Telegraph' use Britain as a synonym for the United Kingdom. Some prefer to use Britain as shorth ...

United Kingdom
, benefits are typically indexed for inflation (known as Retail Prices Index (RPI)) as required by law for registered pension plans. Inflation during an employee's retirement affects the purchasing power of the pension; the higher the inflation rate, the lower the purchasing power of a fixed annual pension. This effect can be mitigated by providing annual increases to the pension at the rate of inflation (usually capped, for instance at 5% in any given year). This method is advantageous for the employee since it stabilizes the purchasing power of pensions to some extent. If the pension plan allows for early retirement, payments are often reduced to recognize that the
retiree A pensioner is a person who receives a pension A pension (, from Latin Latin (, or , ) is a classical language belonging to the Italic languages, Italic branch of the Indo-European languages. Latin was originally spoken in the area around ...
s will receive the payouts for longer periods of time. In the United States, under the
Employee Retirement Income Security Act of 1974 The Employee Retirement Income Security Act of 1974 (ERISA) (, codified in part at ) is a federal United States tax and labor law Labour law (also known as labor law or employment law) mediates the relationship between workers, employing entit ...
, any reduction factor less than or equal to the
actuarial Actuarial science is the discipline that applies mathematics, mathematical and statistics, statistical methods to Risk assessment, assess risk in insurance, finance, and other industries and professions. More generally, actuaries apply rigorous m ...
early retirement reduction factor is acceptable. Many DB plans include early retirement provisions to encourage employees to retire early, before the attainment of normal retirement age (usually age 65). Companies would rather hire younger employees at lower wages. Some of those provisions come in the form of additional ''temporary'' or ''supplemental benefits'', which are payable to a certain age, usually before attaining normal retirement age. Due to changes in pensions over the years, many pension systems, including those in
Alabama (We dare defend our rights) , anthem = "Alabama (We dare defend our rights) , anthem = "Alabama (state song), Alabama" , image_map = Alabama in United States.svg , seat ...
,
California California is a state State may refer to: Arts, entertainment, and media Literature * ''State Magazine'', a monthly magazine published by the U.S. Department of State * The State (newspaper), ''The State'' (newspaper), a daily newspaper i ...
,
Indiana Indiana () is a U.S. state in the Midwestern United States, Midwestern United States. It is the List of U.S. states and territories by area, 38th-largest by area and the List of U.S. states and territories by population, 17th-most populous o ...
, and
New York New York most commonly refers to: * New York City, the most populous city in the United States, located in the state of New York * New York (state), a state in the northeastern United States New York may also refer to: Film and television * New ...
, have shifted to a tiered system. For a simplified example, suppose there are three employees that pay into a state pension system: Sam, Veronica, and Jessica. The state pension system has three tiers: Tier I, Tier II, and Tier III. These three tiers are based on the employee's hire date (i.e. Tier I covers 1 January 1980 (and before) to 1 January 1995, Tier II 2 January 1995 to 1 January 2010, and Tier III 1 January 2010 to present) and have different benefit provisions (e.g. Tier I employees can retire at age 50 with 80% benefits or wait until 55 with full benefits, Tier II employees can retire at age 55 with 80% benefits or wait until 60 for full benefits, Tier III employees can retire at age 65 with full benefits). Therefore, Sam, hired in June 1983, would be subject to the provisions of the Tier I scheme, whereas Veronica, hired in August 1995, would be permitted to retire at age 60 with full benefits and Jessica, hired in December 2014, would not be able to retire with full benefits until she became 65.


DB funding

Defined benefit plans may be either ''funded'' or ''unfunded''. 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, or PAYGO''. The social security systems of many European countries are unfunded, having benefits paid directly out of current taxes and social security contributions, although several countries have hybrid systems which are partially funded. Spain set up the Social Security Reserve Fund and France set up the Pensions Reserve Fund; in Canada the wage-based retirement plan (CPP) is partially funded, with assets managed by the
CPP Investment Board The Canada Pension Plan Investment Board (CPPIB; french: Office d'investissement du régime de pensions du Canada), operating as CPP Investments (french: RPC Investissements), is a Canadian Crown corporation A state-owned enterprise (SOE) ...
while the U.S.
Social Security Welfare (or commonly, social welfare) is a type of government support intended to ensure that members of a society can meet basic human needs Maslow's hierarchy of needs is an idea in psychology Psychology is the science of mind and ...
system is partially funded by investment in special U.S. Treasury Bonds. In a ''funded'' plan, contributions from the employer, and sometimes also from plan members, are invested in a fund towards meeting the benefits. All plans must be funded in some way, even if they are pay-as-you-go, so this type of plan is more accurately known as pre-funded or fully-funded. The future returns on the investments, and the future benefits to be paid, are not known in advance, so there is no guarantee that a given level of contributions will be enough to meet the benefits. Typically, the contributions to be paid are regularly reviewed in a valuation of the plan's assets and liabilities, carried out by an
actuary An actuary is a business professional who deals with the measurement and management of risk and uncertainty. The name of the corresponding field is actuarial science. These risks can affect both sides of the balance sheet and require investment m ...
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.


DB criticisms

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 a J-shaped accrual pattern of benefits, where the present value of benefits grows quite slowly early in an employee's career and accelerates significantly in mid-career: in other words it costs more to fund the pension for older employees than for younger ones (an "age bias"). Defined benefit pensions tend to be less
portable Portable may refer to: General * Portable building, a manufactured structure that is built off site and moved in upon completion of site and utility work * Portable classroom, a temporary building installed on the grounds of a school to provide ad ...
than defined contribution plans, even if the plan allows a lump sum cash benefit at termination. Most plans, however, pay their benefits as an annuity, so retirees do not bear the risk of low investment returns on contributions or of outliving their retirement income. The open-ended nature of these risks to the employer is the reason given by many employers for switching from defined benefit to defined contribution plans over recent years. The risks to the employer can sometimes be mitigated by discretionary elements in the benefit structure, for instance in the rate of increase granted on accrued pensions, both before and after retirement. The age bias, reduced portability and open ended risk make defined benefit plans better suited to large employers with less mobile workforces, such as the public sector (which has open-ended support from taxpayers). This coupled with a lack of foresight on the employers part means a large proportion of the workforce are kept in the dark over future investment schemes. Defined benefit plans are sometimes criticized as being paternalistic as they enable employers or plan trustees to make decisions about the type of benefits and family structures and lifestyles of their employees. However they are typically more valuable than defined contribution plans in most circumstances and for most employees (mainly because the employer tends to pay higher contributions than under defined contribution plans), so such criticism is rarely harsh. The "cost" of a defined benefit plan is not easily calculated, and requires an actuary or 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 lifespan of the employees, the returns to be earned by the pension plan's investments and any additional taxes or levies, such as those required by the Pension Benefit Guaranty Corporation in the U.S. So, for this arrangement, the benefit is relatively secure but the contribution is uncertain even when estimated by a professional. This has serious cost considerations and risks for the employer offering a pension plan. One of the growing concerns with defined benefit plans is that the level of future obligations will outpace the value of assets held by the plan. This "underfunding" dilemma can be faced by any type of defined benefit plan, private or public, but it is most acute in governmental and other public plans where political pressures and less rigorous accounting standards can result in excessive commitments to employees and retirees, but inadequate contributions. Many states and municipalities across the United States of America and Canada now face chronic pension crises.


DB examples

Many countries offer state-sponsored retirement benefits, beyond those provided by employers, which are funded by
payroll A payroll is the list of employees of some company that is entitled to receive payments as well as other work benefits and the amounts that each should receive. Along with the amounts that each employee should receive for time worked or tasks per ...
or other taxes. In the United States, the Social Security system is similar in function to a defined benefit pension arrangement, albeit one that is constructed differently from a pension offered by a private employer; however, Social Security is distinct in that there is no legally guaranteed level of benefits derived from the amount paid into the program. Individuals that have worked in the UK and have paid certain levels of national insurance deductions can expect an income from the state pension scheme after their normal retirement. The state pension is currently divided into two parts: the basic state pension, State Second ierPension scheme called S2P. Individuals will qualify for the basic state pension if they have completed sufficient years contribution to their national insurance record. The S2P pension scheme is earnings related and depends on earnings in each year as to how much an individual can expect to receive. It is possible for an individual to forgo the S2P payment from the state, in lieu of a payment made to an appropriate pension scheme of their choice, during their working life. For more details see
UK pension provision Pensions in the United Kingdom, whereby United Kingdom residents have some of their wages deducted to save for retirement, can be categorised into three major divisions - state, occupational and personal pensions. Automatic enrolment has been suc ...
.


Defined contribution plans

A defined contribution (DC) plan, is a pension plan where employers set aside a certain proportion (i.e. contributions) of a worker's earnings (such as 5%) in an investment account, and the worker receives this savings and any accumulated investment earnings upon retirement. These 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, sometimes through the purchase of an annuity which then provides a regular income. Defined contribution plans have become 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 pension contributions as a large expense avoidable by disbanding the defined benefit plan and instead offering a defined contribution plan. Money contributed can either be from employee salary deferral or from employer contributions. 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 do not need to pay an actuary to calculate the lump sum equivalent that you do for defined benefit plans) in practice, defined contribution plans have become generally
portable Portable may refer to: General * Portable building, a manufactured structure that is built off site and moved in upon completion of site and utility work * Portable classroom, a temporary building installed on the grounds of a school to provide ad ...
. In a defined contribution plan, investment risk and investment rewards are assumed by each individual/employee/retiree and not by the sponsor/employer, and these risks may be substantial. In addition, participants do not necessarily purchase annuities with their savings upon retirement, and bear the risk of outliving their assets. (In the United Kingdom, for instance, it is a legal requirement to use the bulk of the fund to purchase an annuity.) 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. A defined contribution plan typically involves a number of service providers, including in many cases: * Trustee * Custodian * Administrator * Recordkeeper * Auditor * Legal counsel * Investment management company


DC examples

In the United States, the legal definition of a defined contribution plan is 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 ). Examples of defined contribution plans in the United States include
individual retirement account An individual retirement account (IRA) in the United States is a form of "individual retirement plan", provided by many financial institutions, that provides tax advantage Tax advantage refers to the economic bonus which applies to certain accounts ...
s (IRAs) and 401(k) plans. In such plans, the employee is responsible, to one degree or another, for selecting the types of
investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance Finance is the study of financial institution ...

investment
s toward which the funds in the retirement plan are allocated. This may range from choosing one of a small number of pre-determined
mutual fund A mutual fund is a professionally managed investment fund An investment fund is a way of investment, investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group such as reducing the ri ...
s to selecting individual
stock In finance, stock (also capital stock) consists of all of the shares In financial markets A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities i ...

stock
s or other
securities A security is a tradable financial asset A financial asset is a non-physical asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication o ...
. Most self-directed retirement plans are characterized by certain
tax advantage Tax advantage refers to the economic bonus which applies to certain accounts or investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, su ...
s, 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. Advocates of defined contribution plans point out that each employee has the ability to tailor the investment portfolio to his or her individual needs and financial situation, including the choice of how much to contribute, if anything at all. However, others state that these apparent advantages could also hinder some workers who might not possess the financial savvy to choose the correct investment vehicles or have the discipline to voluntarily contribute money to retirement accounts. In the US, defined contribution plans are subject to
IRS The Internal Revenue Service (IRS) is the revenue service A revenue service, revenue agency or taxation authority is a government agency responsible for the intake of government revenue, including taxes and sometimes non-tax revenue. ...
limits on how much can be contributed, known as the section 415 limit. In 2009, the total deferral amount, including employee contribution plus employer contribution, was limited to $49,000 or 100% of compensation, whichever is less. The employee-only limit in 2009 was $16,500 with a $5,500 catch-up. These numbers usually increase each year and are indexed to compensate for the effects of inflation. For 2015, the limits were raised to $53,000 and $18,000, respectively. Examples of defined contribution pension schemes in other countries are, the UK's personal pensions and proposed
National Employment Savings Trust The National Employment Savings Trust (NEST) is a defined contributionA defined contribution (DC) plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis. Individual accounts are set up for ...
(NEST), Germany's Riester plans, Australia's Superannuation system and New Zealand's KiwiSaver scheme. Individual pension savings plans also exist in Austria, Czech Republic, Denmark, Greece, Finland, Ireland, Netherlands, Slovenia and Spain


Risk sharing pensions

Many developed economies are moving beyond DB & DC Plans and are adopting a new breed of collective risk sharing schemes where plan members pool their contributions and to a greater or less extent share the investment &
Longevity risk A longevity risk is any potential risk attached to the increasing life expectancy Life expectancy is a statistical measure of the average (see below) time an organism is expected to live, based on the year of its birth, its current age, and o ...
. There are multiple naming conventions for these plans reflecting the fact that the future payouts are a ''target'' or ''ambition'' of the plan sponsor rather than a guarantee, common naming conventions include: * Defined Ambition Plans * Target benefit plans * Collective Defined Contribution Schemes *
Tontine A tontine () is an investment plan for raising capital, devised in the 17th century and relatively widespread in the 18th and 19th centuries. It enables subscribers to share the risk of living a long life by combining features of a group annuity ...
Pensions (the original
Longevity risk A longevity risk is any potential risk attached to the increasing life expectancy Life expectancy is a statistical measure of the average (see below) time an organism is expected to live, based on the year of its birth, its current age, and o ...
sharing scheme invented in 1653).


Risk sharing pension sponsor examples

* Canada: Healthcare of Ontario Pension Plan (HOOPP) * US: State of Wisconsin Investment Board * US:
TIAA The Teachers Insurance and Annuity Association of America-College Retirement Equities Fund (TIAA, formerly TIAA-CREF), is a Fortune 100 The ''Fortune'' 500 is an annual list compiled and published by '' Fortune'' magazine that ranks 500 of the ...
* APAC/Europe: Tontine Trust * UK:
Royal Mail Royal Mail Group plc is a British multinational mail, postal service and courier company, originally established in 1516 as a department of the English government. The company's subsidiary Royal Mail Group Limited operates the brands Royal Mail (le ...

Royal Mail
Pension Fund * Netherlands:
Stichting Pensioenfonds ABP Stichting Pensioenfonds ABP ("National Civil Pension Fund"), frequently referred to as ABP, is the pension fund for government and education employees in the Netherlands. For the quarter ended 31 December 2014, ABP had 2.8 million participants and ...
* Denmark: Arbejdsmarkedets Tillægspension


Other pension plan types


Hybrid and cash balance plans

Hybrid plan designs combine the features of defined benefit and defined contribution plan designs. A
cash balance plan A cash balance plan is a defined benefit retirement plan that maintains hypothetical individual employee accounts like a defined contribution plan. The hypothetical nature of the individual accounts was crucial in the early adoption of such plan ...
is a defined benefit plan made to appear as if it were a defined contribution plan. They have ''notional balances'' in hypothetical accounts where, typically, each year the plan administrator will contribute an amount equal to a certain percentage of each participant's salary; a second contribution, called ''interest credit'', is made as well. These are not actual contributions and further discussion is beyond the scope of this entry suffice it to say that there is currently much controversy. In general, they are usually treated as
defined benefit planA defined benefit (DB) pension plan is a type of pension plan in which an employer/sponsor promises a specified pension payment, lump-sum or combination thereof on retirement that is predetermined by a formula based on the employee's earningsEarnin ...
s for 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 Portable may refer to: General * Portable building, a manufactured structure that is built off site and moved in upon completion of site and utility work * Portable classroom, a temporary building installed on the grounds of a school to provide ad ...
than traditional defined benefit plans and perhaps more attractive to a more highly mobile workforce. Target benefit plans are defined contribution plans made to match (or resemble) defined benefit plans.


Contrasting types of retirement plans

Advocates of defined contribution plans point out that each employee has the ability to tailor the investment portfolio to his or her individual needs and financial situation, including the choice of how much to contribute, if anything at all. However, others state that these apparent advantages could also hinder some workers who might not possess the financial savvy to choose the correct investment vehicles or have the discipline to voluntarily contribute money to retirement accounts. This debate parallels the discussion currently going on in the U.S., where many
Republican Republican can refer to: Political ideology * An advocate of a republic, a type of government that is not a monarchy or dictatorship, and is usually associated with the rule of law. ** Republicanism, the ideology in support of republics or against ...
leaders favor transforming the Social Security system, at least in part, to a self-directed investment plan.


Financing

Defined contribution pensions, by definition, are funded, as the "guarantee" made to employees is that specified (defined) contributions will be made during an individual's working life. There are many ways to finance a pension and save for retirement. Pension plans can be set up by an employer, matching a monetary contribution each month, by the state or personally through a pension scheme with a financial institution, such as a bank or brokerage firm. Pension plans often come with a tax break depending on the country and plan type. For example, Canadians have the option to open a Registered Retirement Savings Plan (RRSP), as well as a range of employee and state pension programs. This plan allows contributions to this account to be marked as un-taxable income and remain un-taxed until withdrawal. Most countries' governments will provide advice on pension schemes.


Financing structure

Social and state pensions depend largely upon legislation for their sustainability. Some have identified funds, but these hold essentially government bonds - a form of "IOU" by the state which may rank no higher than the state's promise to pay future pensions. Occupational pensions are typically provided through employment agreements between workers and employers, and their financing structure must meet legislative requirements.  In common-law jurisdictions, the law requires that pensions be pre-funded in trusts, with a range of requirements to ensure the trustees act in the best interests of the beneficiaries.  These jurisdictions account for over 80% of assets held by private pension plans around the world. Of the $50.7 trillion of global assets in 2019, $32.2T were in U.S. plans, the next largest being the U.K. ($3.2T), Canada  ($2.8T), Australia ($1.9T), Singapore ($0.3T), Hong Kong and Ireland (each roughly $0.2T), New Zealand, India, Kenya, Nigeria, Jamaica, etc. Civil-law jurisdictions with statutory trust vehicles for pensions include the Netherlands ($1.8T), Japan ($1.7T), Switzerland ($1.1T), Denmark ($0.8T), Sweden, Brazil and S. Korea (each $0.5T), Germany, France, Israel, P.R. China, Mexico, Italy, Chile, Belgium, Spain and Finland (each roughly $0.2T), etc.  Without the vast body of common law to draw upon, statutory trusts tend to be more uniform and tightly regulated. However, pension assets alone are not a useful guide to the total distribution of occupational pensions around the world.  It will be noted that four of the largest economies (Germany, France, Italy and Spain) have very little in the way of pension assets.  Nevertheless, in terms of typical net income replacement in retirement, these countries rank well relative to those with pension assets. These and other countries represent a fundamentally different approach to pension provision, often referred to as "intergenerational solidarity." Intergenerational solidarity operates to an extent in any country with a defined-benefit social security system, but is more controversial when applied to high levels of professional income.  Why should younger generations pay for executive pensions which they themselves are unsure of collecting?  Employers have sought ways of getting round this problem through pre-funding, but in civil-law countries have often been limited by the legal vehicles available.  A suitable legal vehicle should ideally have three qualities: ·       It should convince employees that the assets are truly secured for their benefit; ·       Contributions to the vehicle should be tax-deductible to the employer (or at least, a tax deduction should be secured already), and ·       To the extent that it has funded the pension liability, the employer may reduce the liability shown on its balance sheet. In the absence of appropriate statute, attempts have been made to invent suitable vehicles with varying degrees of success.  The most notable has been in Germany where, until the end of the 20th century, most occupational pensions were unfunded ("book-reserved") promises by employers.  Changes started in 1983 and by 1993 the preamble to proposed regulations under Section 404A of the U.S. Internal Revenue Code stated (when discussing deductible contributions to the German equivalent of a trust): ''"…the Security Contract combines a book reserve commitment by an employer with a pledge and guaranty.  First, an employer establishes a book reserve for its pension liabilities for which it receives a deduction under German law. It then establishes a wholly-owned subsidiary to which it transfers assets to fund its pension liabilities… e subsidiary pledges its assets irrevocably to a custodian who then gives a guaranty to the employees to pay the benefits up to the assets pledged to the custodian in the event an employer declares bankruptcy or goes into receivership.  The custodian's guaranty is intended to place a prior lien on the assets pledged and protect them from the claims of the employer's creditors in the event of bankruptcy or receivership.''" In December 2000, a magazine article described: ''"...an artificial legal construction which, via a series of legal pledges between the employer, the employee and a separate custodian of the created pension fund, makes it possible to overcome the limitations of German law and establish what is effectively an Anglo Saxon-style trust. This is a model which has created a great deal of interest in Germany, and several big name employers have already adopted a similar approach to enable unrestricted funding of their occupational pension schemes. Examples include Shell, Daimler-Chrysler and Hewlett Packard."'' As of August 2021, a major accounting firm describes what it calls the "market standard": ''"...the standard instrument for the (out-) financing of pension commitments... From the employer's point of view, this primarily serves the purpose of taking pension provisions off the balance sheet but also the purpose of ensuring insolvency protection under private law of those pension claims that are not covered by the statutory insolvency protection.... In practice, so-called double-sided CTAs have become market standard, at the latest since the judgement of the German Federal Labour Court (Bundesarbeitsgericht, BAG) of 18 July 2013 (6 AZR 47/12). In this ruling, the BAG assumed the resistance to insolvency of a double-sided CTA when it comes to the insolvency protection of credit balances of employees from part-time employment relationships with older employees. The double-sided CTA comprises the trustee's administrative trust relationship with the employer for the administration of the trust assets as well as the security trust relationship between the trustee and the pension beneficiary, which is aimed at fulfilling the company pension commitment in the defined security cases. The outsourcing of pension provisions for accounting purposes requires that the trust assets which the trustor contributes to the CTA - depending on the applicability of German GAAP/HGB or IFRS accounting approach - meet the balance sheet requirements as netting cover assets (section 246 (2) sentence 2 HGB) or as netting plan assets (IAS 19.8)... The... trust assets contributed to the CTA by the trustor may only be used to meet the claims of the beneficiaries."'' It therefore seems fair to say that first tax deductions, then favorable accounting treatment, spurred innovation in pension-financing structure which secured beneficiaries' rights, quite independently of government initiative. Similar developments have occurred elsewhere, but the large scale of the German pension assets involved (not officially measured but at least in the several tens of billion dollars) make its story unique.


History

In the classical world, Romans offered veteran legionnaires (centurions) military pensions, typically in the form of a land grant or a special, often semi-public, appointment.
Augustus Caesar Augustus (23 September 63 BC19 August AD 14) was the first Roman emperor The Roman emperor was the ruler of the Roman Empire during the imperial period (starting in 27 BC). The emperors used a variety of different titles through ...

Augustus
Caesar (63 B.C.–A.D. 14) introduced one of the first recognisable pension schemes in history with his military treasury. In 13 B.C. Augustus created a pension plan in which retired soldiers were to receive a pension (of minimum 3,000 denarii in a lump sum, which at the time represented around 13 times a legionnaires’ annual salary) after 16 years of service in a legion and four years in the military reserves. The retiring soldiers were in the beginning paid from general revenues and later from a special fund (''aeririum militare'') established by Augustus in 5 or 6 A.D.Clark, R. L., Craig, L. A., & Wilson, J. W. (n.d.). A History of Public Sector Pensions in the United States. Philadelphia, Pennsylvania 19104-4011: University of Pennsylvania Press. Retrieved from https://pensionresearchcouncil.wharton.upenn.edu/wp-content/uploads/2015/09/0-8122-3714-5-3.pdf This was in an attempt to quell a rebellion within the Roman Empire which was facing militaristic turmoil at the time. This, whilst did ease tensions within the empire, allegedly became one of the main reasons for the Empires eventual collapse as it struggled to finance the extensive support to which it committed itself. Despite helping the military, the Empire did little to help ordinary systems as the concept of social security came around at a much later time in history. Widows' funds were among the first pension type arrangement to appear. For example, Duke Ernest the Pious of
Gotha Gotha () is the fifth-largest city in Thuringia Thuringia (; german: Thüringen ), officially the Free State of Thuringia ( ), is a state State may refer to: Arts, entertainment, and media Literature * ''State Magazine'', a monthly magazi ...

Gotha
in Germany founded a widows' fund for clergy in 1645 and another for teachers in 1662. 'Various schemes of provision for ministers' widows were then established throughout Europe at about the start of the eighteenth century, some based on a single premium others based on yearly premiums to be distributed as benefits in the same year.' Modern forms of pension systems were first introduced in the late 19th century. Germany was the first country to introduce a universal pension program for employees.


Germany

As part of
Otto von Bismarck Otto, Prince of Bismarck, Count of Bismarck-Schönhausen, Duke of Lauenburg (german: Otto Fürst von Bismarck, Graf von Bismarck-Schönhausen, Herzog zu Lauenburg ; 1 April 1815 – 30 July 1898), born Otto Eduard Leopold von Bismarck, was a c ...

Otto von Bismarck
's social legislation, the Old Age and Disability Insurance Bill was enacted and implemented in 1889. The Old Age Pension program, financed by a tax on workers, was originally designed to provide a pension annuity for workers who reached the age of 70 years, though this was lowered to 65 years in 1916. Unlike accident insurance and health insurance, this program covered industrial, agrarian, artisans and servants from the start and was supervised directly by the state. Germany's mandatory state pension provisions are based on the pay-as-you-go (or redistributive) model. Funds paid in by contributors (employees and employers) are not saved and neither invested but are used to pay current pension obligations. Recently, the German government has come under criticism for the impending disaster posed by the exorbitant tax burden resulting from civil servants' pensions. A study, commissioned by the Taxpayers Association, that Professor Bernd Raffelhüschen of the Generation Contracts Research Center of the University of Freiburg carried out states that by 2050, the state will have to spend 1.3 to 1.4 trillion EUR to supply its civil servants. The majority of it, about 870 billion EUR, is therefore spent on pensions. The federal government's financial statements for 2016 already show the extent of that disaster. According to this, the expected costs for pensions and subsidies for medical treatment for the number of federal civil servants at the end of 2016 will amount to 647 billion EUR over the course of the next ten years. That is 63 billion EUR more than in the previous year - an increase of ten percent in just one year. The sum is divided into: * Pension obligations of EUR 477.96 billion (plus 9.7 percent) and * Aid obligations of EUR 169.02 billion (plus 13.4 percent). Officials, judges and soldiers account for 238.4 billion EUR of the expected pension expenditure of almost 478 billion EUR. In addition, there are legacy issues from the times of large state-owned companies: the federal government has to pay out 171 billion EUR for old-age pensions for former postal officials and 68.5 billion EUR for former railway officials. The problem: while the government preaches private pension provision to workers, the state itself has failed to build adequate reserves for the wave of pensions in the coming years. The federal government has been trying to create a cushion since 2007. So far, however, this has amounted to only 14 billion EUR by 2018. Professor Bernd Raffelhüschen criticised that the state had made high pension commitments for decades, "but initially didn't build up any reserves for a long time." Pensions, thus, represent a considerable burden for public budgets. As Professor Bernd Raffelhüschen calculated in his study in 2005, the present value of the pension burden for the federal states amounts to 1,797 billion EUR, which is larger than the Germany's total public debt. In various federal states, efforts are being made to secure pension expenditure by setting up pension funds for newly hired civil servants. Fiscal relief is, however, to be expected only when the newly hired officials retire. The share of tax revenue needed to supply for the pensions will increase from approximately 10% in 2001 in many federal states to over 20% in 2020. In the extreme case of the city-state of Hamburg, every fourth euro of income will be used to finance pensions for their retired civil servants.


Ireland

There is a history of pensions in
Ireland Ireland ( ; ga, Éire ; Ulster Scots dialect, Ulster-Scots: ) is an island in the Atlantic Ocean, North Atlantic. It is separated from Great Britain to its east by the North Channel (Great Britain and Ireland), North Channel, the Irish Sea ...

Ireland
that can be traced back to
Brehon Law Early Irish law, historically referred to as (English: Freeman-ism) or (English: Law of Freemen), also called Brehon law, comprised the statutes which governed everyday life in Early Medieval Ireland Early may refer to: History * The begin ...
imposing a legal responsibility on the kin group to take care of its members who were aged, blind, deaf, sick or insane. For a discussion on pension funds and early Irish law, see F Kelly, ''A Guide to Early Irish Law'' (Dublin,
Dublin Institute for Advanced Studies The Dublin Institute for Advanced Studies (DIAS) ( ga, Institiúid Ard-Léinn Bhaile Átha Cliath) is a statutory, independent research institute in Ireland Ireland (; ga, Éire ; Ulster Scots dialect, Ulster-Scots: ) is an island in the ...
, 1988). In 2010, there were over 76,291 pension schemes operating in Ireland.


United Kingdom

The decline of Feudal systems and formation of national states throughout Europe led to the reemergence of standing armies with their allegiances to states. Consequently, the sixteenth century in England marked the establishment of standardised systems of military pensions. During its 1592–93 session, Parliament established disability payments or “reliefe for Souldiours ... adventured their lives and lost their limbs or disabled their bodies” in the service of the Crown. This pension was again generous by contemporary standards, even though annual pensions were not to exceed ten pounds for “private soldiers,” or twenty pounds for a “lieutenant.” The beginning of the modern state pension came with the
Old Age Pensions Act 1908 The Old-Age Pensions Act 1908 is an Act of Parliament In modern politics and history, a parliament is a legislative body of government. Generally, a modern parliament has three functions: Representation (politics), representing the Electio ...
, that provided 5 shillings (£0.25) a week for those over 70 whose annual means do not exceed £31.50. It coincided with the
Royal Commission on the Poor Laws and Relief of Distress 1905-09 Royal may refer to: People * Royal (name)Royal can be a surname or a given name. Bearers include: Surname * Billy Joe Royal (1942–2015), American country music and pop singer * Calvin Royal III, American ballet dancer * Darrell Royal (1924 ...
and was the first step in the
Liberal welfare reforms The Liberal welfare reforms (1906–1914) were a series of acts of social legislation passed by the Liberal Party (UK), Liberal Party after the 1906 United Kingdom general election, 1906 general election. They represent the emergence of the moder ...
to the completion of a system of social security, with unemployment and health insurance through the
National Insurance Act 1911 The National Insurance Act 1911 created National Insurance, originally a system of health insurance for industrial workers in Great Britain based on contributions from employers, the government, and the workers themselves. It was one of the founda ...
. In 1921, The Finance Act introduced tax relief on pension contributions in line with savings and life insurance. As a consequence, the overall size of the fund was increased since the income tax was now added to the pension as well. Then in 1978, The
State Earnings-Related Pension SchemeThe State Earnings Related Pension Scheme (SERPS), originally known as the State Earnings Related Pension Supplement, was a UK Government The Government of the United Kingdom, domestically referred to as Her Majesty's Government, is the centra ...
(SERPS) replaced The Graduated Pension Scheme from 1959, providing a pension related to earnings, in addition to the basic state pension. Employees and employers had the possibility to contribute to it between 6 April 1978 and 5 April 2002, when it was replaced by the
State Second Pension The State Second Pension (S2P), or Additional State Pension, was introduced in the United Kingdom, UK by the Labour Party (UK), Labour Government on 6 April 2002, to replace the SERPS (State Earnings-Related Pension Scheme). The main aim of this cha ...
. After the Second World War, the
National Insurance Act 1946 The National Insurance Act 1946 (c 67) was a British British may refer to: Peoples, culture, and language * British people, nationals or natives of the United Kingdom, British Overseas Territories, and Crown Dependencies. ** Britishness, the B ...
completed universal coverage of social security, introducing a State Pension for everybody on a contributory basis, with men being eligible at 65 and women at 60. The
National Assistance Act 1948 The National Assistance Act 1948 is an Act of Parliament passed in the United Kingdom by the Labour government of Clement Attlee. It formally abolished the Poor Law system that had existed since the reign of Elizabeth I, and established a social saf ...
formally abolished the poor law, and gave a minimum income to those not paying National Insurance. The early-1990s established the existing framework for state pensions in the
Social Security Contributions and Benefits Act 1992 The Social Security Contributions and Benefits Act 1992c 4 is the primary legislation concerning the state retirement provision, accident insurance, statutory sick pay and maternity pay in the United Kingdom. Contents *Part I Contributions *Part ...
and Superannuation and other Funds (Validation) Act 1992. Following the highly respected
Goode Report''Pension Law Reform'' (1993) Cm 2342, also known as the Goode Report after its leading author, Roy Goode Sir Royston Miles "Roy" Goode (born 6 April 1933) is an academic commercial lawyer in the United Kingdom. He founded the Centre for Commerci ...
, occupational pensions were covered by comprehensive statutes in the
Pension Schemes Act 1993 The Pension Schemes Act 1993c 48 is a United Kingdom Act of Parliament that concerns the administration of occupational pensions. Background The Pension Schemes Act 1993 was the first statute to result from the comprehensive inquiry led by Roy Goo ...
and the
Pensions Act 1995 The Pensions Act 1995c 26 is a piece of United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain,Usage is mixed. The Guardian' and Telegraph' use Britain as a synonym for t ...
. In 2002, the
Pensions Commission The Pensions Commission was a non-departmental public bodyIn the United Kingdom, non-departmental public body (NDPB) is a classification applied by the Cabinet Office, HM Treasury, Treasury, the Scottish Government and the Northern Ireland Executive ...
was established as a cross-party body to review pensions in the United Kingdom. The first Act to follow was the
Pensions Act 2004 The Pensions Act 2004 (c 35) is an Act of Parliament, Act of the Parliament of the United Kingdom to improve the running of pension schemes. Background In the years following the introduction of the Pensions Act 1995, it was widely perceived that ...
that updated regulation by replacing OPRA with the
Pensions Regulator The Pensions Regulator (TPR) is a non-departmental public bodyIn the United Kingdom, non-departmental public body (NDPB) is a classification applied by the Cabinet Office, HM Treasury, Treasury, the Scottish Government and the Northern Ireland Exec ...
and relaxing the stringency of minimum funding requirements for pensions while ensuring protection for insolvent businesses. In a major update of the state pension, the
Pensions Act 2007 The Pensions Act 2007 (c 22) is an Act of Parliament, Act of the Parliament of the United Kingdom. It incorporated the main findings of the all-party Pensions Commission in 2006 as set out in the white paper ''Security in retirement: towards a new ...
, which aligned and raised retirement ages. Following that, the
Pensions Act 2008 The Pensions Act 2008c 30 is an Act of the Parliament of the United Kingdom The Parliament of the United Kingdom is the Parliamentary sovereignty in the United Kingdom, supreme Legislature, legislative body of the United Kingdom, the Crown ...
has set up automatic enrolment for
occupational pensions A pension (, from Latin Latin (, or , ) is a classical language belonging to the Italic languages, Italic branch of the Indo-European languages. Latin was originally spoken in the area around Rome, known as Latium. Through the power of the R ...
, and a public competitor designed to be a low-cost and efficient fund manager, called the
National Employment Savings Trust The National Employment Savings Trust (NEST) is a defined contributionA defined contribution (DC) plan is a type of retirement plan in which the employer, employee or both make contributions on a regular basis. Individual accounts are set up for ...
(or "Nest").


United States

First "American" pensions came in 1636, when
Plymouth colony Plymouth Colony (sometimes Plimouth) was an British America, English colonial venture in America from 1620 to 1691 at a location that had previously been surveyed and named by Captain John Smith (explorer), John Smith. The settlement served as t ...
, and subsequently, other colonies such as Virginia, Maryland (1670s) and NY (1690s), offered the first colonial pension. The general assembly of the
Virginia Company The Virginia Company was an English trading companyTrading companies are business Business is the activity of making one's living or making money by producing or buying and selling Product (business), products (such as goods and services). ...
followed by approving a resolution known as Virginia Act IX of 1644 stating that "...all hurt or maymed men be relieved and provided for by the several counties, where such men reside or inhabit." Furthermore, during
King Philip's War King Philip's War (sometimes called the First Indian War, Metacom's War, Metacomet's War, Pometacomet's Rebellion, or Metacom's Rebellion) was an armed conflict in 1675–1678 between indigenous inhabitants of New England and New England coloni ...
, otherwise known as the First Indian War, this Act was expanded to widows and orphans in Virginia's Act of 1675. Public pensions got their start with various 'promises', informal and legislated, made to veterans of the
Revolutionary WarRevolutionary War(s) may refer to: * American Revolutionary War (1775–1783), the armed conflict between Great Britain and 13 of its North American colonies, which had declared themselves the independent United States of America * French Revolution ...
and, more extensively, the
Civil War A civil war, also known as an intrastate war in polemology, is a war War is an intense armed conflict between states State may refer to: Arts, entertainment, and media Literature * ''State Magazine'', a monthly magazine publis ...
. They were expanded greatly, and began to be offered by a number of state and local governments during the early
Progressive Era The Progressive Era (1896–1916) was a period of widespread social activism Activism consists of efforts to promote, impede, direct, or intervene in Social change, social, Political campaign, political, Economics, economic, or Natural ...
in the late nineteenth century. Federal civilian pensions were offered under the
Civil Service Retirement System The Civil Service Retirement System (CSRS) was organized in 1920 and has provided retirement, disability, and survivor benefits for most civilian employees in the United States The United States of America (USA), commonly known as the United ...
(CSRS), formed in 1920. CSRS provided retirement, disability and survivor benefits for most civilian employees in the US Federal government, until the creation of a new Federal agency, the
Federal Employees Retirement System The Federal Employees' Retirement System (FERS) is the retirement system for employees within the United States civil service The United States federal civil service is the civilianIn general use, a civilian is "a person who is not a member of th ...
(FERS), in 1987. Pension plans became popular in the United States during
World War II World War II or the Second World War, often abbreviated as WWII or WW2, was a global war A world war is "a war War is an intense armed conflict between states State may refer to: Arts, entertainment, and media Literatur ...
, when wage freezes prohibited outright increases in workers' pay. The defined benefit plan had been the most popular and common type of retirement 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. In April 2012, the
Northern Mariana Islands The Northern Mariana Islands, officially the Commonwealth of the Northern Mariana Islands (CNMI; ch, Sankattan Siha Na Islas Mariånas; cal, Commonwealth Téél Falúw kka Efáng llól Marianas), is an unincorporated territories of the Unit ...

Northern Mariana Islands
Retirement Fund filed for
Chapter 11 Chapter 11 of the United States Bankruptcy Code ( Title 11 of the United States Code The Code of Laws of the United States of America (variously abbreviated to Code of Laws of the United States, United States Code, U.S. Code, U.S.C., or USC) ...
bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' par ...

bankruptcy
protection. The retirement fund is a
defined benefit A definition is a statement of the meaning of a term (a word In linguistics Linguistics is the scientific study of language A language is a structured system of communication used by humans, including speech (spoken language ...
type pension plan and was only partially funded by the government, with only $268.4 million in
asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such a ...
s and $911 million in
liabilities Liability may refer to: Law * Legal liability, in both civil and criminal law ** Public liability, part of the law of tort which focuses on civil wrongs ** Product liability, the area of law in which manufacturers, distributors, suppliers, reta ...
. The plan experienced low investment returns and a benefit structure that had been increased without raises in funding. According to ''Pensions and Investments'', this is "apparently the first" US public pension plan to declare bankruptcy.


Current challenges

A growing challenge for many nations is
population ageing Population ageing is an increasing median age A population pyramid or "age-sex pyramid" is a graphical illustration of the distribution of a population In biology, a population is a number of all the organisms of the same group or species ...
. As birth rates drop and
life expectancy Life expectancy is a statistical measure of the average time an organism is expected to live, based on the year of its birth, its current age, and other demographic Demography (from prefix ''demo-'' from Ancient Greek Ancien ...

life expectancy
increases an ever-larger portion of the population is elderly. This leaves fewer workers for each retired person. In many developed countries this means that government and
public sector The public sector (also called the state sector) is the part of the economy composed of both public service A public service is a service Service may refer to: Activities :''(See the Religion section for religious activities)'' * Administ ...
pensions could potentially be a drag on their economies unless pension systems are reformed or taxes are increased. One method of reforming the pension system is to increase the retirement age. Two exceptions are
Australia Australia, officially the Commonwealth of Australia, is a Sovereign state, sovereign country comprising the mainland of the Australia (continent), Australian continent, the island of Tasmania, and numerous List of islands of Australia, sma ...

Australia
and
Canada Canada is a country in the northern part of North America North America is a continent A continent is any of several large landmasses. Generally identified by convention (norm), convention rather than any strict criteria, ...

Canada
, where the pension system is forecast to be
solvent A solvent (from the Latin Latin (, or , ) is a classical language belonging to the Italic languages, Italic branch of the Indo-European languages. Latin was originally spoken in the area around Rome, known as Latium. Through the power of the ...
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: immigrants tend to be of working age. 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 ageing to the extent as those in Europe, Australia, or Canada. Another growing challenge is the recent trend of states and businesses in the United States purposely under-funding their pension schemes in order to push the costs onto the federal government. For example, in 2009, the majority of states have unfunded pension liabilities exceeding all reported state debt. Bradley Belt, former 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." Challenges have further been increased by the post-2007 credit crunch. Total funding of the nation's 100 largest corporate pension plans fell by $303bn in 2008, going from a $86bn surplus at the end of 2007 to a $217bn deficit at the end of 2008.


Pillars

Most national pension systems are based on multi-pillar schemes to ensure greater flexibility and financial security to the old in contrast to reliance on one single system. In general, there are three main functions of pension systems: saving, redistribution and insurance functions. According to the report by the World Bank titled "Averting the Old Age Crisis", countries should consider separating the saving and redistributive functions, when creating pension systems, and placing them under different financing and managerial arrangements into three main pillars. The Pillars of Old Age Income Security: However, this typology is a rather prescriptive one than descriptive and most specialists usually allocate all public programmes to the first pillar, including earnings-related public schemes, which does not fit the original definition of the first pillar.OECD (2006), “Pension-system Typology”, in OECD Pensions at a Glance 2005: Public Policies across OECD Countries, OECD Publishing, Paris. https://doi.org/10.1787/pension_glance-2005-3-en


Zero pillar

This non-contributory pillar was introduced only recently, aiming to alleviate poverty among the elderly, and permitting fiscal conditions. It is usually financed by the state and is in form of basic pension schemes or social assistance.Holzmann, R., Hinz, R., von Gersdorff, H., Gill, I., Impavido, G., Musalem, A. R., … Subbarao, K. (2005). Old-Age Income Support in the 21st Century: An International Perspective on Pension Systems and Reform (pp. 10–10). N.W. Washington, D.C. 20433,USA: The International Bank for Reconstruction and Development / THE WORLD BANK. Retrieved from http://siteresources.worldbank.org/INTPENSIONS/Resources/Old_Age_Inc_Supp_Full_En.pdf In some typologies, the zero and the first pillar overlap.


First pillar

Pillar 1, sometimes referred to as ''the public pillar'' or ''first-tier'', answers the aim to prevent the poverty of the elderly, provide some absolute, minimum income based on solidarity and replace some portion of lifetime pre-retirement income. It is financed on a redistributive principle without constructing large reserves and takes the form of mandatory contributions linked to earnings such as minimum pensions within earnings-related plans, or separate targeted programs for retirement income. These are provided by the public sector and typically financed on pay-as-you-go basis.


Second pillar

Pillar 2, or ''the second tier,'' built on the basis of defined benefit and defined contribution plans with independent investment management, aims to protect the elderly from relative poverty and provides benefits supplementary to the income from the first pillar to contributors.[Terziev, Venelin. (2019). HISTORICAL DEVELOPMENT AND CHARACTERISTICS OF PENSION SYSTEMS. 5. 124-135.] Therefore, the second pillar fulfils the insurance function. In addition to DB's and DC's, other types of pension schemes of the second pillar are ''the contingent accounts'', known also as Notional Defined Contributions (implemented for example in Italy, Latvia, Poland and Sweden) or ''occupational pension schemes'' (applied, for instance, in Estonia, Germany and Norway).


Third pillar

The third tier consists of voluntary contributions in various different forms, including occupational or private saving plans, and products for individuals.


Fourth Pillar

The fourth pillar is usually excluded from classifications since it does not usually have a legal basis and consists of "informal support (such as family), other formal social programs (such as health care or housing), and other individual assets (such as home ownership and reverse mortgages)." These 5 pillars and their main criteria are summarised in the table below by Holzmann and Hinz. Multipillar Pension Taxonomy:


Different channels for Governments to finance the retirement pension

Government can play with four different channels to finance the retirement pension. These Economic policy, economic policies are the following ones: * Decrease of real pensions, * Increase of employee social contribution, * Increase of employer social contribution, * Increase of the retirement age. These channels have been used by many governments to implement new retirement pension reforms. In the past, they had been sometimes simultaneously used (two or three channels used in the same time for a pension reform) or with a targeted way (on a certain group of persons such as in a certain business sector). Retirement pensions turn out to be considerable amounts of money. For instance, in Pensions in France, France, it is about 300 billion euros each year, namely 14-15% of French GDP. It is therefore very interesting and informative to illustrate the impacts of these different channels to finance the retirement pension, especially nowadays since many riots take place in different countries against new retirement pension reforms or willing to change the national retirement pension process. Simulating these economic policies is then useful to understand every mechanism linked to these channels. Four different channels to finance retirement pensions will be simulated successively and will allow to explain their impacts on main economic variables presented below with an eight-year horizon. Some software of macroeconomic simulation allows to compute and display them. The implementation of these economic shocks and their mechanisms will be analysed in the following sections. The economic variables of interest are various but the main ones can be chosen as follows: Gross domestic product, GDP level (impact in %), total employment level (impact in %), price index (impact in %), price growth rate (impact in points), Current account (balance of payments), current account (impact in GDP points), public finance balance (impact in GDP points) An objective relation may also be used. This one is a linear combination of the previous variables. This one is weighted according to the prominence given to some variables. For instance, if the government mainly focuses on GDP level and public finance balance, their assigned coefficient can be chosen as 0.3 each (the sum of the coefficients must be equal to 1). Other more specific variables could be used such as: household expenses level, corporate investments level, domestic demand level, purchasing power level and the like. As a consequence, simulations are very relevant for everyone to understand the impacts of these channels to finance the retirement pension. However, simulations could be used in a reverse manner. Given the objective of government to get an economic variable improvement by a certain number, the four channels can be adjusted in order to achieve this goal. For example, a government may have an objective to get a public finance improvement by 2/3 GDP point the year 8. In order to lead these simulations, the choice of hypotheses assumed is crucial. Concerning exchange rates, one can use the Purchasing power parity, Purchasing Power Parity (PPP) measurement which happens to be an absolute purchasing power comparison in the countries concerned. Regarding interest rates, one can choose the Taylor rule, Taylor Rule with a risk premium coefficient of -0.1. External trade price elasticities can also be assumedtobe -1. When it comes to Monetary Union, it depends on which country the study and thus the simulations are led. A Monetary Union can be concerned with any country. However, in order to get consistent results, a country such as Germany, France or Italy could be analysed. In this case, the monetary union is established with other European countries members of the euro area. Finally, every economic policy is led in the country concerned only.


Decrease of real pensions

This economic shock is to permanently decrease the amount of real pensions paid to retirees by for example 1 Gross domestic product, GDP point. Transfers from public power to households are therefore dropped by 1 GDP point. In the case of France (given 14-15% of GDP corresponds to retirement pensions), this is a drop of 7.5% of mass pension benefits. It proves to be demand shock insofar as the household’s Disposable and discretionary income, available income decreases in the short term. This drop of purchasing power implies a diminishment of Consumption (economics), consumption and of demand in general. The activity is then negatively affected. However, the Current account (balance of payments), current account is improved as imports decrease following the reduce of domestic demand. In the medium term, since this cut of consumption and demand, unemployment increases. The price index decreases as the consumption price drops. As a consequence, exports increase. The real Direct labor cost, labour cost falls increasing thus companies’ margins which limits the degradation of investments. The drop of consumption remains higher than the increase of current account which thereby results in the decrease of GDP. The public finance balance increases following the diminishment of pension benefits spent to retirees. However, unemployment benefits increase and given the drop of consumption and of household’s incomes, which implies a fall in the incomes received from income tax and VAT by public administration.


Increase of employee social contribution

This economic shock involves the permanent increase of employee social contribution by for instance 2 points. This social contribution is spent by household as a share of mass wages received by them. It turns out to be a demand shock because household’s Disposable Income, disposable income decreases from the short term. Indeed, the income perceived by employees is reduced following the increase of employee social contribution. As the previous channel, the drop of purchasing power result in a diminishment of consumption and demand in general. It implies a drop in activity. However, the Current account (balance of payments), current account is improved as imports are reduced following the cut of interior demand. In the medium term, the implications are similar to the decrease of real pensions. Employment and the price index decrease. Exports increase and the drop of investments is limited. The Gross domestic product, GDP decreases too. Finally, in the short term, the public finance balance increases but is quickly limited (but remains an increase) with the decrease of revenues from Value-added tax, VAT and income taxes and the increase of unemployment.


Increase of employer social contribution

This economic shock is to permanently increase employer social contribution by for instance 2 points. This social contribution is spent by employer as a share of mass wages paid to each employee. It proves to be a Supply shock, supply economic shock. Indeed, the rise of the Direct labor cost, labour cost degrades the labour demand and increases the costs of production. The Competition (economics), competitivity is degraded and results in the drop of the purchasing power. Job losses are then attended: the unemployment strongly increases. This shock is also inflationary given that household’s consumption prices rise. As corporations’ profitability drops, exports and companies’ investment fall too. The current account drops and this shock is not Expansionism, expansionist: the GDP decreases. Finally, the public finance balance is improved but less than planned. Indeed, employer social contribution is increased but it happens to be less than expected as unemployment rises. In addition, income tax is lower than before the shock, employee social contribution increases and unemployment benefits expenses increase.


Increase of the retirement age

This economic shock involves an increase of the retirement age. To do so, it implies a permanent increase in the working age of for instance 2% and to decrease the number of retirees of an equivalent amount. For this last step, it is tantamount to decrease global real pensions by a certain number of GDP point. In order to find this precise number for the simulation, we can assume people live on average 80 years, study during 20 years and are retirees during 20 years. As a consequence, an increase of 2% for life expectancy at work amounts to a decrease of 4% for life expectancy in retirement. Real pensions make globally a certain percentage of the GDP according to the country chosen. By knowing it, you can finally find the certain number of GDP point to simulate the decrease of number of retirees. For instance, in France real pensions make globally around 15% of GDP. Finally, -4% of 15% makes a decrease of 0.6 of GDP point. In the short term, this labour force shock (supply policy) leads to an increase of unemployment which negatively affects household’s purchasing power. The consumption decreases along with demand in general which leads to a decrease of activity. However, the Current account (balance of payments), current account is improved as imports are reduced with the drop of domestic demand. In the medium term, through the rise of unemployment, gross salary and the real labour cost progressively decreases. It results in the progressive increase of employment and thus the gradual decrease of unemployment. The household’s consumption prices decrease: this shock is deflationary. The competitivity is improved which lead to a job creation and the boost of economic activity. The GDP increases and this shock is therefore expansionist. Administration’s financing capacity improved in the short term happens to be limited in the medium term. Indeed, the drop of prices decreases the tax bases, especially household income.


Pension systems by country

Pension systems by country:


Notable examples of pension systems by country

Some of the listed systems might also be considered social insurance. * Argentina - ANSES, Administración Nacional de la Seguridad Social * Armenia: ** Pensions in Armenia * Australia: ** Superannuation in Australia - Private, and compulsory, individual retirement contribution system. ** Social Security (Australia), Social Security - Public pensions *Austria: ** Pensions in Austria * Canada: ** Canada Pension Plan ** Old Age Security ** Quebec Pension Plan ** Registered Retirement Savings Plan ** Saskatchewan Pension Plan * Hong Kong ** Mandatory Provident Fund (MPF Schemes) ** Occupational Retirement Schemes (ORSO Schemes) * Finland - Kansaneläkelaitos * France: ** Pensions in France ** Allocation de Solidarité aux Personnes Agées ** Pensions Reserve Fund (France) * India : ** National Pension System ** Employees' Provident Fund Organisation of India * Japan - National Pension (Japan), National Pension * Malaysia - Employees Provident Fund (Malaysia), Employees Provident Fund * Mexico - Mexico Pension Plan * Netherlands - Algemene Ouderdomswet * New Zealand ** Welfare in New Zealand#Superannuation, New Zealand Superannuation – public pensions ** KiwiSaver – Private voluntary retirement contribution system * Nigeria - contributory pension scheme * pension fund administration * pension fund administrator * trustfund pensions limited * NSITF nigeria social insurance trust fund * Poland - Social Insurance Institution * Singapore - Central Provident Fund * South Korea - National Pension Service * Sweden - Social security in Sweden * Switzerland Pension system in Switzerland * Pensions in the United Kingdom, United Kingdom: ** UK pension provision (generally) ** Self-invested personal pensions * United States: ** Public employee pension plans in the United States, Public employee pensions ** Retirement plans in the United States **
Social Security Welfare (or commonly, social welfare) is a type of government support intended to ensure that members of a society can meet basic human needs Maslow's hierarchy of needs is an idea in psychology Psychology is the science of mind and ...
* Vanuatu - Vanuatu National Provident Fund


See also

* Elderly care * Financial advisor and Fee-only financial advisor * Generational accounting * Pension led funding * Pension model * Pensions crisis * Public debt * Retirement * Retirement age * Retirement planning * Social pension Specific: * Bankruptcy Code (disambiguation), Bankruptcy code * Ham and Eggs Movement, California pension proposal of the 1930s-40s * Individual Pension Plan (IPP) * Pension Rights Center * Provident Fund (disambiguation), Provident Fund * Roth 401(k) * Universities Superannuation Scheme


References


Further reading

* *Grünewald A. 2021. "doi:10.1177/0010414021989763, From Benefits and Beneficiaries: The Historical Origins of Old-Age Pensions From a Political Regime Perspective." ''Comparative Political Studies''.


External links


Ranking of Largest Public Pensions

US Retirement

UK State pension
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