Question

Describe how pension funds are administered and the risks involved in contributing to a pension fund.

Answer 1

Definition of Pension Fund

A pension fund, also known as a superannuation fund in some jicountries, is any plan, fund, or scheme which provides retirement income.
Pension funds typically have large amounts of money to invest and are the major investors in listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold about $6 trillion in assets.

Classification of Funds

Open vs. closed pension funds

Open pension funds support at least one pension plan with no restriction on membership while closed pension funds support only pension plans that are limited to certain employees.

Closed pension funds are further subclassified into:

Single employer pension funds
Multi-employer pension funds
Related member pension funds
Individual pension funds

Public vs. private pension funds

A public pension fund is one that is regulated under public sector law while a private pension fund is regulated under private sector law.

In certain countries the distinction between public or government pension funds and private pension funds may be difficult to assess. In others, the distinction is made sharply in law, with very specific requirements for administration and investment. For example, local governmental bodies in the United States are subject to laws passed by the states in which those localities exist, and these laws include provisions such as defining classes of permitted investments and a minimum municipal obligation .

Defined-Contribution Plans

With a defined-contribution plan, you have several options when it comes time to shut that office door.

Leave-In: You could just leave the plan intact and your money where it is. You may, in fact, find the firm encouraging you to do so. If so, your assets will continue to grow tax-deferred until you take them out. Under the IRS' required minimum distribution rules, you have to begin withdrawals once you reach age 70½. There may be exceptions, however, if you are still employed by the company in some capacity.22

Installment: If your plan allows it, you can create an income stream, using installment payments or an income annuity—sort of a paychecks-to-yourself arrangement throughout the rest of your retirement lifetime.23 If you annuitize, bear in mind that the expenses involved could be higher than with an IRA.

Roll Over: You can rollover your 401(k) funds to a traditional IRA, where your assets will continue to grow tax-deferred. One advantage of doing this is that you will probably have many more investment choices. You can then convert some or all of the traditional IRA to a Roth IRA. You can also roll over your 401(k) directly into a Roth IRA. In both cases, although you will pay taxes on the amount you convert that year, all subsequent withdrawals from the Roth IRA will be tax-free. In addition, you are not required to make withdrawals from the Roth IRA at age 70½ or, in fact, at any other time during your life. 24 25

Lump-Sum: As with a defined-benefit plan, you can take your money in a lump sum26 . You can invest it on your own or pay bills, after paying taxes on the distribution. Keep in mind, a lump-sum distribution could put you in a higher tax bracket, depending on the size of the distribution.

These are the risk involved in contributing to the pension Fund

Pension fund investment risk comes from three main sources: risk that the fund will fall in value, risk that the pension fund's returns will not keep pace with inflation (real returns are negative), and risk that the pension fund does not perform well enough to keep pace with the growth in the cost of providing pension benefits.

Your tolerance for investment risk will generally depend on your type of pension arrangement and how far you are from retirement.

Members bear the investment risk in defined contribution schemes, personal pensions and PRSAs. Generally, employers bear the risk in funded defined benefit schemes, although if the employer cannot fund the scheme, the investment risk ultimately falls back on the member.

It is, therefore, important that you know what risks you are taking within your pension fund and keep these under review.