Pensions are retirement benefits that employers promise to pay their employees after they’ve retired. Pension funds are large investment funds that manage the money that’s been set aside to make those payments.
Story: Marissa the Math Teacher
The idea of pensions is credited to the Romans, who set them up for their best soldiers (Centurions). Since then, pensions have been used by both governments and corporations as either a reward for long-term employment, or a safety net.
Most pension recipients today are government employees like teachers, firefighters and other civil servants (most corporations have stopped offering pensions, to save money).
The idea is that if you work a certain number of years, you’ll get paid a certain amount (e.g. some percentage of your salary) each year after you retire, for life.
Let’s imagine a math teacher named Marissa, who’s retiring after forty years in her school district. Why a math teacher? Because you almost have to be one to understand pensions – they’re one big equation (money in and money out).
Marissa reads the fine print of her pension plan, and investigates the investment returns of the pension fund that manages it, called BOTS (Bureaucratic Office for Teachers Statewide).
Right away, she notices her pension depends on some big assumptions:
- Her employer (the state) will put enough money into the BOTS fund every year to ‘fully fund’ every employee’s expected retirement payouts.
- The BOTS fund managers will do a great job investing the fund, growing the money enough so the future promised payout is available.
- Her fellow teachers will live only as long as expected – otherwise the BOTS fund could run out of money too soon.
The actual assumptions (rates of investment return etc.) are hidden in a complicated spreadsheet.
Marissa suspects that few people really understand this spreadsheet, and that the BOTS fund managers have an interest in making the numbers look good now, but might not care as much if they actually come true later.
She’s also heard that pension funds in general have been investing more aggressively lately, putting money into riskier asset classes like hedge funds, venture capital and private equity, in search of higher returns.
Will Marissa’s pension work out? She’ll find out over the next couple of decades. But the pension fund investment managers at BOTS will get paid big bucks whatever happens, because they’re hired professionals.
If you’re a worker relying on a future pension, you may want to ask a math teacher like Marissa to look into the numbers for your own pension system.
Because pensions are all about the math.