Pension funds will benefit from the sharp rise in shares prices in recent days. But not all the people paying into the funds will benefit directly. Pension funds are invested in shares as well as in property, Government bonds and cash. Any rise in the value of shares will increase the value of the overall pension fund, just as any fall in the share values will reduce the value of the fund. But the benefit to members of a fund will depend on the type of pension plan or scheme they have entered into and the overall value of the fund at their retirement date.
There are three main types of pension scheme: defined benefits, defined contributions and personal plans. In a defined benefit plan a person makes a regular weekly or monthly contribution into a fund and is guaranteed a specific or defined benefit on retirement, often half or two-thirds of salary at retirement. For people in a defined benefit scheme the rise in the value of shares would make no difference to what they would get if they were to retire next week.
They have signed on for a defined benefit and that is what they will get.
But if there was a sustained rise in the value of the fund the employer could allow a surplus to build up and then reduce the firm's and/or the employee's contributions to the fund for a period. Or an employer could use a surplus to offer early retirement.
A sustained rise in share values and thus the value of the fund is more immediately beneficial to people in personal plans or defined contribution plans. In a personal plan a contributor - often directors of small companies - puts in, typically, 10 per cent to 15 per cent of his/her annual salaries. This contribution is invested and becomes the contributor's pension fund. The benefit to the contributor on retirement is based on what the fund is worth at that time. Therefore, if the equity market is strong close to the retirement date, the contributor will get the benefit. In practice, it is usual to move most of the funds out of equities and into more conservative investments about five years prior to retirement to avoid potential losses from volatile equity markets.
In a defined contribution scheme, the employee and the employer pay in specific weekly or monthly contributions - often 5 per cent of salary for the employee and 10 per cent for the employer. The benefit, as in the personal plan, is based on the value of the scheme at the date of retirement. Only in the defined benefit plan is the value of the pension pre-determined and, therefore, fluctuations in share values will have no impact on the payout to the contributors.
