ELi5 how do pension funds generate a surplus?
In: 10
Pension funds put your money into a giant pool of money that then gets invested to earn interest. The account can collect more money and earn more interest than it expects to pay out that year creating a surplus.
Pension funds don’t sit in a room somewhere. The funds are invested and so they make money like any other investment. Surplus happens when investment returns exceeds the amount the fund needs to have
Corporation can have pension funds as a lender. They would borrow money, pay interest on the lent money, and generate a return for the pension. This is generally how pensions make money to fund the future liability. There are bits about inflation linked borrowing and whatnot, but that’s more nitty gritty details. The important part is the pension has alot of money that it doesn’t need now but will need later and the corporation needs alot of money now and hopes to grow their business so that they can pay it back later.
EDIT: I don’t mean they can borrow from their own pension funds. That is super illegal.
Pension funds have assets and liabilities. Money coming in vs money going out. When the money coming in is more than the money going out, you have a surplus.
As for examples of how these amounts change:
Pension funds derive much of their funding from workers. In many skilled trades unions, the contractor pays X dollars an hour into a pension fund. The amount per hour can vary due to wage negotiations. Perhaps you enter the union when contributions are 5/hr and by the time you retire, contributions are 15/hr.
Man hours can go up and down in busier and slower years. This impacts the contributions to the fund. More hours worked means more money into the fund.
The contributions are often leveraged in various investments. Stocks, bonds, etc. The rate of return for those investments can impact the value of the funds. If the market is up, funds may be up. If the market is down, the funds may be down.
On the flip side, your liabilities (payout) is also changing. This simplest example of this is that people die and they can die before they have realized their contributions.
You’ve also got things like vesting periods. Employees that don’t stick around long enough to become vested in the fund won’t have access to their contributions. So they provide assets without becoming a liability.
You’ve also got potential changes concerning the details of how money is paid out. Pensions are fixed benefit plans that promise X benefit due to X contributions across X years. If the “formula” changes, then liabilities can become larger or smaller. This can become even more complicated with early or late retirement “bonuses”.
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