Defined Benefit Fund

A defined benefit fund pays a fixed income to the beneficiary, regardless of how well the fund does. The employee pays a fixed amount into the fund. The fund managers invest these contributions conservatively. They must beat inflation without losing the principal. The fund manager must earn enough of a return on the investment to pay for the benefits.

The employer must pay for any shortfall. It's like an annuity provided by an insurance company. In this case, the employer functions as the insurance company and sustains all the risk if the market drops. That risk is why many companies have stopped offering these plans.

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The multi-employer plans allow small companies to band together to create diversified pensions. Employees benefit from being able to change companies without losing their pension benefits. There are 10 million current and retired workers in multi-employer plans.

 

 Many of them will probably run out of funds.

The benefits of these plans are guaranteed by the federal government's Pension Benefit Guaranty Corporation. The ISG guarantees the pension incomes for 35 million workers. The Single-Employer program successfully covers 28 million participants. The Multiemployer program faces insolvency by 2025. That's because 130 multiemployer plans will run out of money by 2040.

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Defined Contribution Plan

In a defined contribution plan, the employee's benefits depend on how well the fund does. The most common of these are 401(k)s. The employer doesn't have to pay out defined benefits if the fund drops in value. All the risk is transferred to the employee. The shift in risk is the most important difference between the defined benefit and the defined contribution plan.

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Issues

In the 1980s, corporations found that it was more advantageous for them to switch to defined contribution plans. As a result, fewer and fewer employees are covered by these guaranteed payouts. Government plans, including Social Security, stayed with defined benefit plans. But many of their payouts aren't enough to cover a decent standard of living.

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Since then, many managers increased their holding of bonds to lower risk. By 2018, many of the largest funds held a greater percentage of fixed income than they did of stocks and other riskier assets. 

This demand has dried up liquidity for the most popular bonds, making them harder to buy. It's one of the forces that's kept interest rates low, even after the Federal Reserve ended quantitative easing.

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Difference between public pension funds and private pension funds

In a public pension fund referred to as a pay-as-you-go pension plan, contributions paid by the assets are designed to pay pensions for retirees. This system, which is generally compulsory, rests on inter-generational solidarity. Being very vulnerable to unemployment and demographic changes, the financial balance of the system depends on the ratio of the number of contributors to that of the pensioners.

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Unlike this system, private pension funds or fully-funded pension plan is often individual and voluntary, allowing working people to set up their own retirement. They save during their working lives to insure their old age. The contributions received are the subject of financial investments. The return on these investments depends primarily on market developments.

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