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PAGE 8 CHAPTER 8 PENSION FUNDS INTRODUCTION TO PENSION FUNDS A pension plan is a fund that is established for the payment of retirement benefits. Pension plans are set up by plan sponsors to pay retirement benefits. Monies are placed in the funds by the employer/employees and earnings compound tax-free until withdrawn at retirement. The key factor explaining pension fund growth is that the employer’s contributions and specified amount of the employee’s contributions, as well as the earnings of the fund assets, are tax exempt. In essence, a pension is a form of employee remuneration for which the employee is not taxed until funds are withdrawn. TYPE OF PENSION PLANS Defined Benefit Plan In a defined benefit plan, payments are specified upon retirement by the sponsor. The amount available upon retirement becomes a function of the amount placed in the fund and years of service. The pension obligations are effectively the obligation of the plan sponsor, who assumes the risk of insufficient funding to meet contractual payments. Plan sponsors often buy annuities from insurance companies, thereby shifting the risk to these companies. Such plans are called insured benefit plans, though the phrase is a misnomer in that the benefits are guaranteed only so far as the insurance company can provide the funds. The Pension Benefit Guaranty Corporation (PBGC), established under ERISA provides only for vested benefits payments in event of discontinuation by the plan sponsor. Defined benefit plans are expensive and hard to implement when few employees work for only one company over many years. Benefits become vested when employees reach a certain age and complete enough years of service to meet minimum requirement for receiving benefits. In recent years, firms have not adopted defined benefit plans. Major firms that have them have been freezing their plans. This is because they are costly and firms have found that the plans hinder their competitiveness. Defined Contribution Pla