A:

Who actually bears the investment risk in a pension plan depends on the type of pension plan that is employed. In a broad sense, there are two benefit formulas that will calculate the pension benefits the plan member will receive. In the case of a defined-contribution pension plan, the plan member (i.e. the employee) bears all of the investment risk.

The formula for calculating how much an employee under this type of plan will receive is simple, as it only calculates the amount that the plan member and the member's employer will contribute to the pension plan. The amount of cash that is in the fund when the plan member retires is what that person will receive as a pension. There is no guarantee that the plan member will get anything from this defined-contribution plan, as the fund may lose all of its value in the equities markets.

The other type of pension plan is called a defined-benefit pension plan. In this type of plan, the contribution amounts are determined by how much the plan member desires, or is eligible to receive upon retirement and how long the worker has until retirement. Once these figures are known, the contributions that are required to achieve that ending total are determined. In this type of pension plan, the benefits are guaranteed by the employer and, therefore, the company must also bear the investment risk. This investing strategy is called a liability driven investment strategy, and is a key feature of any defined benefit pension plan.

For more insight, see The Demise Of The Defined-Benefit Plan.

RELATED FAQS
  1. The company I am receiving my pension plan from has just filed bankruptcy. Could ...

  2. What's the difference between a 401(k) and a pension plan?

    Discern the differences between 401(k) plans, in which employees assume the market risk, and pension plans, in which the ... Read Answer >>
  3. How do pay-as-you-go pension plans work?

    Learn what a pay-as-you-go pension plan is and how it is different from fully funded pension plans. Understand how public ... Read Answer >>
  4. Are Canadian Pension Plans inflation-protected?

    Learn about the Canada Pension Plan and how it adjusts its contributions and benefits each year for changes in inflation ... Read Answer >>
  5. How do Pay As You Go pension plans work?

    Learn how pay-as-you-go pension plans are different than fully funded pension plans and why some government plans are running ... Read Answer >>
  6. Can I leave my pension to my spouse when I pass away?

    In most cases, an individual with a pension plan should have the option to leave at least a portion of his or her pension ... Read Answer >>
Related Articles
  1. Retirement

    Pension Plans: Pain Or Pleasure?

    Employees have a love/hate relationship with this retirement option.
  2. Retirement

    How Does a Pension Plan Work?

    A pension plan is a savings plan maintained by an employer on behalf of its employees for their retirement.
  3. Retirement

    A Primer On Defined-Benefit Pension Plans

    Most of us will rely on a pension plan in the future, so it's best to know the details of the various plans before signing up.
  4. Retirement

    Florida's Surprisingly Flexible State Retirement System

    Retired Florida employees can choose a 401(k)-style investment plan or a traditional pension.
  5. Retirement

    7 Signs Your Pension Fund Is In Trouble

    Even if you're lucky enough to have a pension plan, you can't assume it'll pay out.
  6. Retirement

    Understanding Defined Benefit Pension Plans

    An employer-sponsored retirement plan where employee benefits are based on a formula using factors such as salary history and duration of employment.
  7. Retirement

    How Safe Is Your Pension?

    A 2014 law permits some private pension plans to reduce benefits. How to figure out if your retirement income is endangered.
  8. Retirement

    More Pension Plans in the Deep Freeze

    A growing number of Fortune 500 companies have sent their defined-benefit pension plans to the deep freeze. What employees should do next.
  9. Financial Advisor

    How to Advise Clients with Frozen Pensions

    Financial advisors are on the front line in advising clients impacted by a frozen pension. Here's what they need to consider.
  10. Financial Advisor

    Are Cash Balance Pensions the Best for Small Biz?

    Are cash balance pensions the right solution for your small business clients? Here's why they may or may not work for your firm.
RELATED TERMS
  1. Plan Participant

    A plan participant either contributes into a pension plan or ...
  2. Unfunded Pension Plan

    An employer managed retirement plan that uses the employer's ...
  3. Cash Balance Pension Plan

    A pension plan under which an employer credits a participant's ...
  4. Fully Funded

    A pension plan that has sufficient assets needed to provide for ...
  5. Pensionable Service

    The period of service, expressed in a yearly figure, for which ...
  6. Pension Adjustment Reversal - PAR

    A numerical calculation in certain Canadian pension plans that ...
Hot Definitions
  1. Put Option

    An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security ...
  2. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  3. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  4. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  5. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  6. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
Trading Center