Terms Behind Pensions Discussion

There are several ways to create and manage pensions plans. Here's the basic breakdown.

To ensure the best possible pension coverage in a country, the World Bank advocates for creation of a multi-pillar system, where each pillar relies on a different method to accrue and manage money in a pension plan. The pillars complement each other and help ensure that most people in a given country will have secured a pension provision for their old age.

	Multi-pillar Pension System
	There are five components or pillars:   0 Pillar: Social assistance schemes, where money is taken from the general revenue to help ensure that the neediest of the elderly don't fall into poverty.   1st Pillar: Earnings-related. These plans tend to be defined benefit, unfunded schemes, such as pay-as-you-go plans.   2nd Pillar: Mandatory savings. These plans are usually fully funded, defined contribution plans.   3rd Pillar: Occupational plans, where the company sets up a saving plan, usually a funded, defined contribution scheme, for its employees.   4th Pillar: Personal, voluntary plans where an individual sets up a private savings account to put aside additional money. There may be tax benefits associated with it.   5th Pillar: Family plan, where a pension is paid to surviving non-working family members.

Defined benefit versus defined contribution

1. Defined benefit: the promise the government gives a worker of how much his or her pension will be, usually determined as a percentage of the last wage.

2. Defined contribution: the percentage of each paycheck that a worker is required to put aside in a pension plan, which is usually mandated by the government. The worker's money is put in an account where it accrues interest until the worker retires.

Financing methods

1. Unfunded or partially funded plans: accumulated assets do not cover liabilities. Defined benefit plans tend to be unfunded. Pay-as-you-go plans (PAYG) fall in this category. In PAYG plans, today's pensions are covered by the wages of the current workforce.

2. Fully funded plans: accumulated assets are equal to liabilities. Defined contribution plans tend to be fully funded. Private mandatory savings fall in this category.

Pension Fund Management

1. The government can manage pension funds directly.

2. The government can contract out the management to private companies.

There is a lot of variation within. For example, In some Latin American countries, the government mandates the amount of money to be saved, but the worker is left to select a pension fund on his own.

Most of the pension plans in the world tend to be government pension plans (partially funded or unfunded defined benefit schemes.) Since Chile introduced a fully funded, privately managed defined contribution scheme in 1981, some two dozens countries have converted a portion of their pension system to this arrangement.