Pension

A pension (also known as superannuation) is a retirement plan intended to provide a person with a secure income for life. Although a lottery may provide a pension, the common use of the term is to describe the payments a person receives upon retirement.

Defined Benefit Plans

The defined benefit plan (as its name implies) defines a benefit for an employee upon that employee's retirement. The benefit in a defined benefit pension plan is determined by a formula, which can incorporate the employee's pay, years of employment, age at retirement, and other factors. A simple example is a flat dollar plan design that provides $100 per month for every year an employee works for a company; with 30 years of employment, that participant would receive $3,000 per month payable for their lifetime. Typical plans in the United States are final average plans where the average salary over the last three or five years of an employees' career determines the pension; in the United Kingdom, benefits are often indexed for inflation. Formulas can also integrate with public Social security plan provisions and provide incentives for early retirement (or continued work).

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Traditional defined benefit plan designs tend to exhibit an S-shaped accrual pattern of benefits, where the present value of benefits grows quite slowly early in an employees' career and accelerates significantly in mid-career. Defined benefit pensions are usually not portable - accrued benefits in defined benefit plans are typically payable only at retirement - even when the employee has a vested interest in the benefit. On the other hand, defined benefit plans typically pay their benefits as an annuity, so retirees do not bear the risk of outliving their retirement income.

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The United States Social Security system is an example of a defined benefit pension arrangements, albeit one that is constructed differently than a pension offered by a private employer.

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The "cost" of a defined benefit plan is not easily calculated, and requires an actuary or actuarial software. However, even with the best of tools, the cost of a defined benefit plan will always be a estimate based on economic and financial assumptions. These assumptions include the average retirement age and life span of the employees, the returns earned by the pension plan's investments and the cost of insurance from the Pension Benefit Guarantee Corporation which is predicted to increase in the near future. So, for this arrangement, the benefit is known but the contribution is unknown even when calculated by a professional.

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In the US, the Internal Revenue Code (IRC) defines a defined benefit plan . The IRC's definition for the defined-contribution plan is an individual account plan -- meaning that employees/participants own an account. Despite the fact that the participant typically has control over investment decisions, the plan sponsor retains a significant degree of fiduciary responsibility over investment of plan assets, including the selection of investment options and administrative providers.

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