How pensions work in the United States
A pension is an income payable after a worker retires,usually at the age of 60 or above,
depending on the provisions of the particular retirement plan.
Pensions can also be paid out earlier if a worker becomes disabled,or to the survivors of a worker who dies.
About 90 percent of all U.S. workers are covered for retirement and disability under SOCIAL SECURITY.
Most of the others are members of some public-employee retirement system.
Perhaps half of all workers in the private sector are covered by some form of private pension or PROFIT-SHARING plan.
Modern retirement plans come in two general forms.
In a defined-benefit plan the amount of the pension is specified by some formula recognizing the worker's length of service and earning history;
then the contributions(from employer and employee) needed to provide the pension are determined.
A defined-contribution plan indicates how the contributions are to be determined on behalf of each employee
and accumulates these contributions in an interest-earning fund;then,at retirement age,
the accumulated fund is applied to provide whatever pension it will.
A typical pension plan,of either type,will be a written document of some complexity.
Among the detailed provisions that will be found are:
1.The rules that determine which workers are eligible to become plan members;
2.The age or ages at which workers can retire,and any choices they may have with respect to retirement age or to the form of the retirement income;
3.The details of the pension formula(if a defined-benefit plan) or of the contribution formula(if a defined-contribution plan);
4.The rules with respect to the disposition of a worker's pension if he or she leaves employment before retirement age or dies;
5.The arrangements by which the employer and employee contribute to the cost of the benefits provided.
Retirement plans can be classified in terms of the entity that sponsors the plan.
When the sponsoring agency is some part of government,the plan is considered to be in the public sector.
When the plan is sponsored by an employer,when it arises out of the collective-bargaining process,
or when it is arranged on an individual basis by the worker,it is said to be in the private sector.
Private pension plans and state or local government accumulate substantial amounts of money awaiting distribution in the form of pensions.
These dollars are invested in virtually every kind of income-producing resource,
including stocks,bonds,mortgages,and real estate.
As pension funds have increased,they have become an increasingly important factor in the nation's economy.
The actual management of pension-fund assets is often the responsibility of some institutional investor-
typically the trust departments of major banks or the investment departments of life insurance companies.
The aging of the American population(there were 25 million people age 65 and over in 1980; an estimated 29.2 million in 1986;
and a projected 64.5 million by the year 2030)has given increased economic importance to pension fund
In the United States,public and private funds totaled $1.4 trillion in 1986,representing an enormous force in financial markets.
Nevertheless,only slightly more than 40 percent of civilian workers were covered by company-provided pensions in the late 1980s.
Control of pension fund investments
It is perfectly possible,although not necessarily wise,for an employer to set up a pension scheme where the benefits,
are paid out of moneies solely provided by the employer out of revenues.
Such a scheme would,of course,be heavily dependent upon the consistency of profits of the employer
and in most circumstances would not give much security to the pensioner or prospective pensioner.
This type of scheme is to be found on the Continent and is generally known as a "Book Reserve Scheme".
Nearly all employers(and the government by virtue of the tax exemptions on investment activities which it gives).
recognise that a more secure base for the payment of pensions can be achieved by setting aside monies in a trust fund and investing them in a variety of Stock Exchange and other securities.
Such a trust fund will consist of the contributions of the employer,the contributions of the employee,
(in the case of a contributory fund),and the investment income from previously acquired investments and those assets themselves.
The management of the trust fund will be carried out by the trustees who are normally appointed by the employer.
(but increasingly from names put forward for appointment by an elective process carried out in conjunction with trade unions and other employee representative bodies
While all the duties of the trustees are extremely important(and they are dealt with elsewhere in this book),among the most onerous is the investment of the trust property.
The manner in which the trustees carry out their investment responsibilities will be governed by the trust deed,
or other instrument under which the pension scheme is constituted.
Most,if not all,modern trust deeds will have a specific investment clause which will permit the trustees to invest over a wide range
which enables them to take full advantage of the various investment outlets available to them.
No matter whether the funds are self-administered,internally or externally managed or wholly managed by an insurance company,
the trustees cannot abrogate their responsibility for the investments of the scheme.
It is,therefore,important that the essentials of policy-making are fully understood.
Investment policy will be a function of the requirements of the scheme.
The vast majority of present-day pension schemes are what are known as "finalsalary" or "defined-benefit" schemes.
In this type of scheme,the pension payable is linked to the salary of the pensioner before retirement.
(perhaps the average of the last five years,three years or,more commonly these days,the salary in the final year).
Final-salary schemes have the merit of at least making sure that the pension,when first paid,
has taken account of inflationary movements in salaries up to the point of retirement.
Such a link is an important factor in the type of investment policy followed.
While final-salary schemes are now the most common,the money purchase or defined-contribution schemes cannot be totally ignored.
(and they have come back into the limelight following the recent decline in the rate of inflation.)
Clearly,an investment policy designed to cater for inflation,at least to the point of retirement,
will be quite different from one which does not attempt to do this.