Pension

Pension is a form of retirement income or a retirement benefit paid to an individual, typically after reaching a specified retirement age or satisfying other eligibility conditions. A pension may be provided through an employer-sponsored Pension plan, a government program, an insurance arrangement, or another retirement system.

Pensions are generally designed to provide income after an individual leaves the workforce. The amount and duration of pension payments depend on the structure of the underlying arrangement and may be determined by a benefit formula, accumulated retirement assets, contributions, investment returns, or other factors.

Types

Pensions may be provided through different types of retirement arrangements, including:

defined benefit pension plans;
defined contribution pension plans;
government pension programs;
occupational pension schemes;
individual retirement arrangements;
annuity-based retirement arrangements.

The terminology and structure of pension systems vary among jurisdictions.

Pension plan

A Pension plan is a formal retirement arrangement that establishes rules for contributions, investment, benefit calculation, and distribution.

A pension plan may be structured as a defined benefit or defined contribution arrangement.

Defined benefit pension

Under a Defined benefit pension plan, the retirement benefit is determined according to a predetermined formula.

A simplified formula may be expressed as:

$Annual Pension = Accrual Rate \times Years of Service \times Pensionable Salary$

The actual calculation depends on the rules of the particular pension plan.

In a traditional defined benefit arrangement, the plan sponsor generally assumes significant responsibility for funding and investment risks associated with the promised benefit.

Defined contribution pension

Under a Defined contribution pension plan, contributions are specified, while the eventual retirement benefit generally depends on the accumulated value of the retirement account.

A simplified representation is:

$Retirement Value = Contributions + Investment Returns - Fees and Withdrawals$

Investment performance and other factors therefore influence the retirement income ultimately available to the participant.

Pension fund

A Pension fund is a pool of assets established to finance pension benefits.

Pension funds may invest in:

equities;
bonds;
government securities;
real estate;
infrastructure;
cash and cash equivalents;
other permitted investments.

The assets are managed according to the objectives, obligations, risk tolerance, and regulatory requirements of the pension arrangement.

Pension contributions

Pension contributions may be made by:

employees;
employers;
governments;
other participating organizations.

Contribution arrangements vary according to the pension system and plan design.

Retirement income

A pension may provide income through:

periodic payments;
lifetime payments;
fixed-term payments;
annuity payments;
other permitted retirement distributions.

The amount and duration of payments depend on the underlying pension arrangement.

Pension and retirement age

Eligibility for pension benefits may depend on factors such as:

age;
years of service;
contribution history;
employment status;
disability or other qualifying conditions;
statutory eligibility requirements.

The applicable conditions vary among pension systems.

Pension funding

Pension funding refers to the accumulation and management of financial resources required to provide future pension benefits.

For a defined benefit pension plan, the funding position may be assessed using a funding ratio:

$Funding Ratio = \frac{Pension Plan Assets}{Present Value of Pension Obligations} \times 100 %$

A funding ratio below 100% generally indicates that measured plan assets are less than measured pension obligations under the assumptions used.

Pension risks

Pension arrangements may involve several financial and demographic risks, including:

investment risk;
inflation risk;
interest-rate risk;
longevity risk;
liquidity risk;
funding risk.

The allocation of these risks differs between defined benefit and defined contribution arrangements.

Longevity risk

Longevity risk is the risk that an individual lives longer than anticipated and therefore requires retirement income for a longer period.

Longevity risk is particularly relevant to arrangements that provide benefits for the lifetime of the beneficiary.

Inflation risk

Inflation risk arises when increases in prices reduce the purchasing power of pension income.

Some pension arrangements provide inflation-linked or inflation-adjusted benefits, while others provide fixed or otherwise predetermined payments.

Pension and asset-liability management

Asset-liability management is particularly relevant to defined benefit pension arrangements because investment assets must support future pension obligations.

Pension funds may seek to coordinate asset cash flows and risk characteristics with expected benefit payments.

Pension governance

Pension arrangements may be administered or governed by:

employers;
trustees;
pension administrators;
government agencies;
insurance companies;
other authorized institutions.

Governance responsibilities may include investment oversight, benefit administration, financial reporting, risk management, and regulatory compliance.

Pension regulation

Pension systems are generally subject to legal and regulatory requirements concerning matters such as:

eligibility;
contributions;
investment;
benefit protection;
taxation;
reporting;
governance.

The specific regulatory framework differs substantially among jurisdictions.

Importance

Pensions are an important component of retirement and social-security systems because they provide mechanisms for transferring financial resources from an individual's working years to retirement. Pension arrangements also represent a major source of long-term institutional capital through the investment of accumulated retirement assets.