The Chinese Pension System
February 12, 2025
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Today, the defined benefit pension plan is viewed as being a relic of the yesteryears. Most of the plans offered now are fixed contribution pension plans. However, a lot of retirees still have a fixed benefit pension plan. Also, it is important to understand how defined benefit pension plans work just for academic purposes.
In the previous article, we already studied how defined benefit plans work. In this article, we will continue to explain the pros and cons of these plans.
Defined benefit pension plans dominated the pension markets for many decades till the 1990s. Such dominance was possible because the company was able to provide several benefits to employees as well as employers. Some of these benefits have been listed below:
Defined benefit plans have virtually zero risk. This is because these plans are also insured to a certain extent. Hence, even if an employer or the fund goes bankrupt, the retirement savings of employees are secured. This security made defined benefit plans the darling of employees for a very long period of time.
Many employees do not have enough knowledge of the financial markets to make informed decisions. Hence, if they are given such choices, it confuses them and leads to unnecessary mental turmoil.
The fixed benefit plans also had some very important disadvantages which ultimately led to their ouster as the preferred pension plan type. Some of these disadvantages have been listed below:
Since companies decide the asset allocation percentage, the investment is generally done very conservatively. The end result is that the annuity rate offered to employees is much lower than the one which would be offered to them on the open market.
Instead, fixed payments are made on a monthly basis. Hence, employees do not have the flexibility to bear lumpsum costs related to their medical expenses, asset purchases, or other such expenses.
To sum it up, defined benefit pension plans had their pros and cons. However, employers are the decision-makers when it comes to the type of pension plan. This type of plan exposed them to a lot of uncertainty and possible financial loss. Hence, over the years, employers have steered away from the role of being a guarantor of retirement benefits toward being a trustee of these savings.
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