Pension Programs

Pension Types

Pensions can be classified according to the following: (1) type of sponsor, (2) type of benefit, and (3) source of funding.

The sponsor can be the government, an employer, or the individual. Government pensions can either develop as social insurance, in [Page 1215]which a person’s pension is directly related to her or his contributions into the system, or they can come through social welfare programs that provide a minimum income floor to the impoverished elderly. Pensions can also be provided by employers as a part of the compensation package for workers. Finally, an individual could start an individual pension plan, usually for personal savings, that is not tied to the workplace or citizenship. Some countries rely exclusively on mandatory public pension programs, while other countries, like the United Kingdom and the United States, mix both public and private and voluntary and mandatory programs.

Second, pensions have two basic types of benefits, defined benefits (DB) and defined contributions (DC). DB plans use a formula based on career earnings and years of service to calculate a specific pension amount to employees at a specified retirement age. DB plans typically distribute benefits only if the worker has attained a specified age or completed a certain number of years of service, and payouts are usually in the form of an annuity for the life of the beneficiary.

In DC plans, workers’ benefits are a function of annual contributions and investment returns, and DC plans do not promise a specific benefit at retirement, hence the term defined contribution. Benefits in DC plans are usually paid as a one-time lump sum amount.

Neither type of benefit is risk-free. For example, inflation may eat into the DB annuity if cost-of-living allowances are not included, and an employer that sponsors a DB plan may fail before the worker can accumulate a sufficient level of benefits.

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