Every pension quietly decides who carries the risk of a long life
A pension looks like a simple promise of money in old age, but its design settles a harder question: if investments sour or a retiree lives far longer than expected, who pays? In a defined benefit plan the employer shoulders that danger. In a defined contribution plan, which now dominates private sector schemes in many countries, the worker does.
The word comes from the Latin pensio, meaning payment. A pension is money paid in regularly during a working career, from a fund or a pay-as-you-go system, then paid out periodically after retirement. That distinguishes it from severance pay, a one-off sum handed over when a job ends involuntarily. Names vary by country: retirement plans in the United States, pension schemes in Britain and Ireland, and super in Australia and New Zealand.
A defined benefit plan fixes the payout by formula. The classic final salary version multiplies years of service by salary at retirement and by an accrual rate, and the employer adjusts contributions to keep that promise. The weakness is underfunding, where obligations race ahead of assets, a problem most acute in public plans exposed to political pressure and looser accounting. Many American and Canadian states and cities now face chronic pension crises, and several states have moved newer hires onto tiers with later retirement ages.
A defined contribution plan fixes only what goes in, perhaps 5 percent of earnings, which is invested in an individual account. Whatever the markets make of it is what the worker gets, so the investment gains, the losses and the chance of outliving the savings all fall on the individual. In Britain, retirees must use most of such a fund to buy an annuity. American employers have steadily abandoned defined benefit schemes as a large and avoidable expense, and the 401(k), funded mainly from workers' own paychecks, has become iconic.
Governments add layers of their own. Contribution-based state pensions, like Social Security in the United States or National Insurance in Britain, depend on a person's payment history, while more than 80 countries offer social pensions meant to keep the elderly out of poverty, some universal as in New Zealand. American military retirees receive retirement pay rather than a pension, because in principle they can still be recalled to active duty.
Source: Pension
