What is Pay-As-You-Go Pension Plan

A pay-as-you-go pension plan is a retirement scheme where the plan beneficiaries decide how much they want to contribute either by having the specified amount regularly deducted from their paycheck or by contributing the desired amount in a lump sum. A pay-as-you-go pension plan is similar to a 401(k). The employee can choose among the various investment options and decide on whether they want a higher return by investing in a more risky fund or a safer fund which provides steady returns.

BREAKING DOWN Pay-As-You-Go Pension Plan

When retirement age comes for the beneficiary of a pay-as-you-go pension plan, they can choose to either receive the benefits in a lump sum or as a lifetime annuity where the benefits are spread in monthly payments throughout the beneficiary's lifetime. This is different from a fully funded pension where the company fully funds, manages and distributes the benefits at retirement.

The level of control exercised by individual participants depends on the structure of the plan and whether the plan is privately or publicly run. Pay-as-you-go pension plans run by governments may use the word "contribution" to describe the money that enters the trust fund, but usually these contributions are taxed at a set rate and neither workers, nor employers, who contribute have any choice about if or how much they pay in to the plan. Private pay-as-you-go pensions, however, offer their participants some discretion.

If an employer offers a pay-as-you-go pension plan, each participant likely gets to choose how much of their paycheck they wish to be deducted and contributed towards your future pension benefits. Depending on the terms of the plan, you can either have a set amount of money pulled out during each pay period or contribute the amount in a lump sum. This is similar to how several defined-contribution plans, such as a 401(k), are funded.

Pay-As-You-Go Pension Plans and Political Risks

One of the main problems faced by pay-as-you-go pension systems is the inherent political risks. These risks refer to decisions made by politicians, which are tied to their traditionally short planning horizons of often only 4 years – a time horizon that is clearly far less than that of a pay-as-you-go pension system. Pay-as-you-go pension systems tend to require periodic adjustments because of demographic and economic uncertainty, and often times, those adjustments depend on discretionary legislation, which may not always have the best long-term interests of pay-as-you-go contributors and beneficiaries. These political risks are very real.