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. 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 >>
  2. 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 >>
  3. 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 >>
  4. How does a defined benefit pension plan differ from a defined contribution plan?

    Learn the differences between defined benefit plans and defined contribution plans when reviewing employer-sponsored qualified ... Read Answer >>
  5. What are qualified retirement plan types?

    Understand the different types of qualified retirement plans and what they mean in terms of employee and employer contribution ... Read Answer >>
Related Articles
  1. Retirement

    Florida's Surprisingly Flexible State Retirement System

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

    Chipping Away At The Pension Freeze Trend

    Learn five steps that'll put your retirement back into your own hands.
  3. Retirement

    New 401(k) Pension Rollover Rule: Pros and Cons

    Is the new rule allowing participants to roll their 401(k) balances into pensions a good idea?
  4. 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.
  5. 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.
  6. Financial Advisor

    How Do Pension Funds Work?

    Traditional private pension funds are well regulated by the government through ERISA and the PBGC. Alternative investments are aiding portfolio returns.
  7. Managing Wealth

    How Pensions, Social Security Differ

    Both pensions and Social Security provide an income stream to retirees, but they differ widely on how they're structured and funded. Here's the lowdown.
  8. Retirement

    Can You Count On Your Pension?

    We look at how to determine the health of your company's pension plan, and what to do if things are looking grim.
  9. Retirement

    5 Big Companies That Have Cut Out Pension Plans

    Companies are putting the responsibility of saving for retirement on the employee.
RELATED TERMS
  1. Unfunded Pension Plan

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

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

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

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

    A numerical calculation in certain Canadian pension plans that ...
  6. Pension Plan

    A type of retirement plan, usually tax exempt, wherein an employer ...
Hot Definitions
  1. Foreign Exchange Reserves

    Foreign exchange reserves are reserve assets held by a central bank in foreign currencies, used to back liabilities on their ...
  2. North American Free Trade Agreement - NAFTA

    A regulation implemented on Jan. 1, 1994, that decreased and eventually eliminated tariffs to encourage economic activity ...
  3. Trickle-Down Theory

    An economic idea which states that decreasing marginal and capital gains tax rates - especially for corporations, investors ...
  4. Derivative

    A security with a price that is dependent upon or derived from one or more underlying assets.
  5. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  6. Sharpe Ratio

    The Sharpe Ratio is a measure for calculating risk-adjusted return, and this ratio has become the industry standard for such ...
Trading Center