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 are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  2. Can my IRA be used for college tuition?

    You can use your IRA to pay for college tuition even before you reach retirement age. In fact, your retirement savings can ... Read Full Answer >>
  3. Why are IRA, Roth IRAs and 401(k) contributions limited?

    Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy ... Read Full Answer >>
  4. How do you calculate penalties on an IRA or Roth IRA early withdrawal?

    With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the ... Read Full Answer >>
  5. What are the best ways to use your 401(k) without a penalty?

    The best way to use your 401(k) retirement savings account is to take normal distributions after you reach retirement age. ... Read Full Answer >>
  6. Is my IRA protected in a bankruptcy?

    All types of individual retirement accounts, or IRAs, recognized under the federal tax code enjoy substantial protection ... Read Full Answer >>
Related Articles
  1. Investing

    Five Things to Consider Now for Your 401(k)

    If you can’t stand still, when it comes to checking your 401 (k) balance, focus on these 5 steps to help channel your worries in a more productive manner.
  2. Professionals

    How to Protect Elderly Clients from Predators

    Advisors dealing with older clients face a specific set of difficulties. Here's how to help protect them.
  3. Professionals

    Social Security 'Start, Stop, Start' Explained

    The start, stop, start Social Security strategy is complicated. Here's what retirees considering it need to consider.
  4. Retirement

    Strategies for a Worry-Free Retirement

    Worried about retirement? Here are several strategies to greatly reduce the chance your nest egg will end up depleted.
  5. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  6. Professionals

    How to Build a Financial Plan for Gen X, Y Clients

    Retirement is creeping closer for clients in their 30s and 40s. It's a great segment for financial advisors to tap to build long-term client relationships.
  7. Professionals

    Don't Let Your Portfolio Be Trump'd by Illiquidity

    A look at Donald Trump's statement of finances and the biggest lesson every investor can learn.
  8. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  9. Retirement

    Maxing Out Your 401(k) Is Profitable: Here's Why

    It's shocking, but most American workers (73%) have no 401(k) retirement funds. Start saving now to anchor your retirement.
  10. Professionals

    Top Questions to Ask When Choosing a Robo-Advisor

    Think a robo-advisor might be the right choice for you? Be sure to ask these questions first.
RELATED TERMS
  1. Qualified Longevity Annuity Contract

    A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity ...
  2. Backdoor Roth IRA

    A method that taxpayers can use to place retirement savings in ...
  3. Current Service Benefit

    The amount of pension benefit accrued by an employee who had ...
  4. Self Invested Personal Pension (SIPP)

    A tax-efficient retirement savings account available in Great ...
  5. Senior Move Manager

    Senior move managers (SMMs) help seniors downsize and relocate ...
  6. Elder Care

    Elder care, sometimes called elderly care, refers to services ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!