What is a pension fund?

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What is a pension fund?

A pension fund is a retirement scheme created by a company or public employer in order to save money for its employees. Belonging to a pension fund may be compulsory or optional. Employees make contributions to the fund, as do employers most of the time.

When an employee retires, they can choose to receive a lump sum right away, or a series of regular payments throughout their retirement, like an annuity. That’s how a funded pension scheme works, because the plan has enough assets to pay retirees for the foreseeable future. On the other hand, with unfunded plans, payments are made directly from contributions and no capital is accumulated.

The pension fund system first developed in Scotland, with the creation of the “Scottish Widows” scheme in 1815. That insured widows of Scottish soldiers killed during the Napoleonic wars with France. Nowadays, pension funds are particularly common in the United States, but the largest pension fund in the world is Japan’s Government Pension Investment Fund. It was created in 1954 and now manages assets of $1.4 trillion.

Pension plans rely on asset management companies to look after the contributions they receive. These companies, generally banks, insurers or specialists, aim to maintain the capital held in the fund and make a profit. American global investment management corporation BlackRock is the number one in the world, with over $7 trillion in assets managed as of the end of 2019.

Their activities are strictly regulated. Each country has its own prudential standards. All capital collected must be divided between a number of asset classes. The primary law governing pension plans in the USA is the Employee Retirement Income Security Act of 1974.

Some funds are defined benefit pension plans, whereby the pension payment or lump sum is guaranteed. But these are getting rarer and rarer, giving way to defined contribution schemes. This means only the contributions collected are guaranteed.

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