17 Jan 2014

Pension Funds

They collect and pool funds which they then invest in order to provide pension entitlements for beneficiaries in the future. The funds are supplied by either or both the individual employee and his/her employer. It is important to make the distinction between a Defined Benefit (DB) and Defined Contribution (DC) pension schemes.

A DB scheme (sometimes referred to as a final salary scheme) guarantees a pension to the employee usually based on the number of years of service at the company. In recent years, the cost of providing this benefit has risen significantly, as DB schemes have been hit by falling returns on investments, falling interest rates (which raise the present value of liabilities) and falling mortality rates (as people live longer, the liabilities will last for much longer). The combination of these factors has led to many established companies running large deficits on their pension schemes, with adverse effects on their financial strength. As a result, many companies have closed their DB schemes to new employees and may also have reduced their payouts. Today, most schemes are DC. Under a DC pension, the employee takes all the investment risk, as the ultimate size of pension he or she will receive will depend on the investment performance of the monies invested over time until retirement.