Pension Fund Definition Benefits Top 10 Public Pension Funds

Pension Fund Definition

Features

Pension Fund provides a steady flow of income to the employees after retirement.In most plans minimum vesting age lies in the range of 40 to 50 years, while the maximum age goes up to 70 years. Vesting age is when a person starts receiving a monthly pension.Most pension plans offer significant tax benefitsTax BenefitsTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place.read more.Many pension plans offer death benefits wherein the policy nomineePolicy NomineeA nominee is an individual or entity that under financial terms gains access to assets and securities, including bank deposits, real property, and stocks, on behalf of the original owner. While serving as a trustee or guardian to safeguard assets in the absence of the actual owner, the designated party gets powers to conduct financial transactions.
read more receives the defined benefit if the pensioner passes away within the policy duration.

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How are Pension Funds Invested?

Historically, pension funds limited their investment to government securities, blue-chip stocksBlue-chip StocksBlue chip stocks are issued by companies possessing large market capitalization. Blue chip companies are market leaders. They provide good returns on stocks, offer dividends, and are considered safe investments.read more, and investment-grade bondsInvestment-grade BondsInvestment grade is the credit rating of fixed-income bonds, bills, and notes as assigned by the credit rating agencies like Standard and Poor’s (S&P), Fitch, and Moody’s to express the creditworthiness of and risk associated with these investments.read more. However, changing market scenarios and the need to generate higher returns has forced pension plans to amend the rules to allow investments in almost all asset classesAsset ClassesAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples.read more. Now, let us look at some of the asset classes they usually invest in.

Fixed Income Investments: Fund managers have expanded their horizons to include high-yield bonds and secured commercial real estate loans to generate higher returns than the conservative fixed income investmentFixed Income InvestmentFixed income investment is a type of investment in which the investor receives a fixed and relatively stable stream of income in the form of dividends or interest over a period of time. Companies and governments typically issue fixed investments in the form of debt securities.read more over the years.Stocks: In most countries, these are some of the largest investors in the stock marketStock MarketStock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price.read more. Typically, fund managersFund ManagersFund management is the process of a company taking a person’s, company’s, or another fund management company’s financial assets (generally high net worth individuals) and investing them in companies that use those funds as an operational investment, financial investment, or any other investment in order to grow the fund.read more focus on a combination of dividend income and growth. Some fund managers also invest in riskier small-cap stocksSmall-cap StocksSmall cap stocks are offered by relatively small companies that are publicly listed. A small cap company has a low market capitalization ranging between $300 million to $2 billion. Small cap investors have a high-risk, high-reward approach.read more for higher growth.Private Equity: It serves the purpose of a long-term alternative investment strategy suited for mature investors. A large portion of the funding for the private equityPrivate EquityPrivate equity (PE) refers to a financing approach where companies acquire funds from firms or accredited investors instead of stock marketsread more industry comes from pension funds.Real Estate usually doesn’t invest directly into real estate but through passive investmentPassive InvestmentPassive investing is a strategy used by investors to maximize their returns by avoiding frequent portfolio churning by buying and selling securities and instead buying and holding a diverse range of securities.read more routes, such as private equity pools or real estate investment trusts (REITs).Infrastructure: They invest a tiny portion of their capital in infrastructure businesses. However, this industry has been growing with a mix of public and private players.

Types of Pension Fund

We can broadly classify Pension Funds based on the benefits offered by the employer – defined benefit fund and defined contribution planDefined Contribution PlanA defined contribution pension plan is when the employer and the employee frequently make a significant amount of contributions to enable employees to save a decent amount of money for the retirement period and leave with the utmost dignity in their retirement phase.read more.

#1 – Defined Benefit Plan

In these types of funds, the fund pays a fixed income to the pensioner irrespective of the fund’s performance. In these funds, the fund manager has to ensure that the fund generates enough return to cover the retirement benefits of the pensioner. In case of any shortfall, the employer must pay the difference. On the other hand, if the fund generates a higher return, then the employers enjoy the benefit. Effectively, the employer bears all the risks in the defined benefit fund.

#2 – Defined Contribution Plan

In these types of funds, the employer’s contribution to the fund is fixed, while the pensioner’s benefits depend on the fund’s performance. So, the employer is not liable to pay out the difference in case the value of the fund drops. Effectively, all the risk transfersRisk TransfersRisk transfer is a risk-management mechanism that involves the transfer of future risks from one person to another. One of the most common examples of risk management is the purchase of insurance, which transfers an individual’s or a company’s risk to a third party (insurance company).read more to the pensioner.

List of Top 10 Largest Public Pension Funds

Below is the list of the top 10 largest public pension funds from across the globe, sorted according to the asset under management (AuM).

Source: Globe Newswire

Regulations of Pension Fund

In the US, private pension plans are regulated by the Employee Retirement Income Security Act (ERISA) of 1974. It defines the minimum standards to be followed while managing a pension plan to safeguard the interest of the participants. It also guarantees employee retirement benefits, under Pension Benefit Guaranty Corporation (PBGC), in case the employer goes out of business. Under PBGC, a 65-year-old retiree is eligible for a maximum guaranteed amount of $69,750 annually. ERISA doesn’t cover public pension funds, which fall under the purview of state governments or state constitutions.

Benefits

Most pension funds offer the flexibility to choose the asset class in which they want to invest – only debt, only equity, or a mix of both.The investment grows tax-free in most of these funds.Since these are invested in long-term assets, the beneficiaries can enjoy long-term investment benefits.

Disadvantages

The income received from these funds after retirement is taxable.Most pension plans are best suited only for the early starters and not all.