Pension is the financial arrangement or gratuity providing retirees' or pensioner's income at regular instalments after they are no longer eligible to receive income from employment, allowing them to make ends meet without formally being employed and continues until death. In other words, a pension provides a pensioner lifetime income security in retirement for however long the retiree lives.



Typically, a pension plan comes into action in the period immediately following retirement, but specifically, a pension fund implies an investment that is created during an individuals working life and utilized upon retirement to acquire an annuity which is then used to provide regular income or a lump-sum payout.

Purpose of Pension

A promised pension plan serves two essential purposes; consumption smoothing and insurance. Consumption smoothing provides an income in retirement when an individual is no longer working. The second is insurance, or the uncertainty attached with longevity, or the length of life.

Unfunded or ‘Paying' for Pension Scheme

PAYG or Pay as you Go is the pension scheme in which young workers pay the pension of retirees from their income, in exchange for the promise that the following generation of workers compensates them the same way.

Funded Pension Scheme

In the funded pension scheme, every individual generation of workers is responsible for maintaining their own pension funds by saving from labor income in a funded plan.

Fundamental Elements of Pension

Both main types of pension arrangements, unfunded and funded, have two essential elements; risk, and time. Workers must save now for a fund that will be accessible to them in the future, therefore converting work years to retirement years. Additionally, there is the involvement of a certain amount of risk with pension plans. The actual payments may be less than those expected when the plan was initiated. Furthermore, there is the risk of the pension plan not being paid at all due to insolvency of the pension scheme itself.

Retirement Plan or Superannuation is a type of pension that is established by the government, insurance companies, employers or even trade unions to provide regular income in the form of an assured annuity.

Employer or Occupational Pension is that which is created by an employer for the benefit of his/her employees upon retirement. An occupational pension may also be considered as a type of differed compensation, for the benefit of both the employer and the employee for tax purposes.

Examples

Examples of pension plans include profit sharing plans, defined benefit plans, ESOPs or employee stock ownership plans, thrift plans, bonus plans, money purchase plans and target benefit plans.

Defined Contribution Plans

In a defined contribution plan, individual contributions which are paid into member accounts (either from member salaries or contributions) are invested usually in the stock market, and all negative and positive investment returns are credited into the members account. Upon retirement, the member gains access to his investment account which also provides additional retirement benefits, which may include annuity that is used to provide a regular income. Defined contribution plans are the most prominent type of pension plan, gaining immense popularity in the private sector.

Defined contribution plans in the U.S. include the 401(k) and Individual Retirement Accounts (IRAs), which allow the member to select the type of investment which his pension fund is allocated to – whether stocks, mutual funds, other securities.

Challenges

Due to the improved health care facilities in developed nations from half a century ago, and better accessibility of high-quality medical care, life expectancy rates are ever-increasing and a large population is elderly. Due to this imbalance, there are fewer workers supporting each retiree. Developed nations are therefore at the crossroads of a significant challenge, one that could collapse their economic systems unless a sustainable pension reform is enforced. One proposed method to be increasing the retirement age. Another could be increasing taxes.