MARKETS: PENSION FUNDS
Pension funds are largely occupational pension schemes run by corporations and other organizations for their employees. Occupational pension funds form the backbone of the institutional fund management industry and their needs determine much of its practice.
It is important not to confuse pension funds with retirement provision. The term ‘pension funds’ refers to corporate occupational funds that are separately identifiable and separately managed.
The investments are managed internally by company executives or by external managers appointed by the fund. This exists in the UK to supplement state provision for retirement, which operates on a pay-as-you-go basis.
Funded occupational pension plans do not all operate on the same basis. Depending on the way the scheme is structured, there is a different allocation of risk between the employee member and the corporate sponsor.
Defined Benefit vs Defied Contribution
A defined benefit (DB) scheme provides the employee with a retirement income based on career earnings, normally related to the final year’s salary. The company is obliged to pay benefits at the contracted rate even if the fund proves inadequate. DB is a promise.
In a defined contribution (DC) plan the individual bears all the investment risk. All contributions are made at a pre-determined rate and the contributing individual has a separately identifiable pot of money. The pension received on retirement is wholly dependent on the value of the investment in the fund at that point in time. The employee has an input into the investment decision but most employers opt for the simple approach of a few investment managers and a restricted choice of funds.
