Institutional investments- the pension schemes - Essay Example

18). These are retirement plans made by insurance companies, the government and other institutions put in place to assist their employers after retirement period. Pension is usually made by the employer’s body in order to enable their employees sustain themselves after retirement as they are not able to be paid their normal salaries after retirement. Through this they will be able to benefit and support themselves. In addition to this, they can be funded by labor unions as well as the government, among other organizations.

Pension schemes can be divided into defined-benefit and defined-contribution pension scheme. Differences between Defined-benefit and Defined-contribution Pension Schemes A defined benefit pension scheme is dependent on the final salary of an employee depending on the member’s length of service and based on a fixed formula (Mathis & Jackson 2012, pg. 11). It can be either funded defined benefit pension scheme or unfunded defined pension scheme whereby the benefits are paid up by the sponsor or the employee.

The funded benefit pension scheme is dependent on the contribution from the plan members and the employer, as well others in the contribution to the pension scheme. A defined contribution pension scheme can be termed as an investment fund at retirement, and which depends on the level of contribution prior to the retirement. This depends on how much each contributor releases to the pension scheme and also on the money contributed in the investment after retirement. The contributions are invested in the stock market where it can succeed or fail.

An example is the Australian superannuation system and the United States section 415, 401 limits among others. A defined benefit pension scheme growth is slow especially at the early years and tends to grow in the mid-work period. This leads to an increase in its costs to older employees as compared to the younger employees, aided by the flat accrual rate and also the decreasing period for interest discounting as retirement period approaches (Redhead 2003, pg. 51). This therefore only favors the companies and not the younger people, making it unpopular among many people.

This leads to the risk of spending a lot of cash and also gets a higher interest led by the time period as it is not funded by the government. The funding makes it to be risky and thus less trusted by most people as it may not be well funded in the future and may also be terminated. Defined contribution pension scheme is a better way or form of investing money as it is put in the stock exchange and through this it is possible to see how one’s portfolio grows. This leads to competition and through this the person or the company can increase its share values and also choose how to can invest.

This is different in the defined benefit pension scheme as the amount or pension paid is not invested as the contribution is fixed. Contributions are also made annually or monthly causing them to get a lower retirement amount as compared to those in defined contribution pension schemes, and thus making people prefer contribution pension schemes over defined benefit pension schemes. Why Defined-contribution Pension Schemes are becoming more important Defined benefit pen