Pension funds are investment pools that pay for workers' retirements. These funds are paid for by either employee, employers, or both. Corporations and all levels of government provide pensions. Companies reduce pension fund risk by relying on fixed income strategies. The real returns for pension funds are often lower than projections.
There are two types of pension funds.
1. 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.
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.