Pension Fund Strategy: DB versus DC

A pension plan is a promise by an employer to provide benefits to employees upon their retirement. Contractual pension fund commitments are a liability of the employer and must be disclosed in the firm's financial statements. A pension fund is established on behalf of employees and is managed by a trustee, who collects cash from the firm, manages the assets owned by the fund, and makes disbursement to retired employees. The firm is able to expense pension fund contributions for tax purposes. The fund pays no taxes on its earning. However, beneficiaries must pay personal taxes upon receiving retirement payments from the fund. Hence pension funds are tax-favoured form of employee compensation because taxes are deferred until retirement. Pension funds hold their assets in the form of marketable securities: money market accounts, bonds and stocks. Direct investment in real estate (with the possible exception of undeveloped land) is not advisable because most real estate investments are priced such that the investor must be in a relatively high tax bracket in order to receive a positive after-tax return. Pension funds are in a zero tax bracket.