Question

6) A) What is the difference between a fully funded and a pay as you go social security system?

B) Which and why would you prefer the one over the other?

Answer 1

a. A pay-as-you-go pension plan is a particular type of pension scheme where the benefits are directly linked to individual members ' contributions or taxes. This contrasts with fully funded pension plans where their future beneficiaries are not actively paying into the pension trust fund. Pay-as-you-go pension plans are sometimes referred to as "pre-funded pension plans." Pay-as-you-go pension plans can be set up by individual companies and governments; one of the best examples of pay-as-you-go elements in a government scheme is the Canada Pension Plan, or CPP.

If your employer provides a pay-as-you-go pension plan, you are likely to be able to choose how much of your paycheck you would like to be deducted and contributed to your future pension benefits. You can either have a set amount of money pulled out during each pay period, or you can contribute the amount in a lump sum, depending on the terms of the plan. This is analogous to how a variety of defined contribution programs are financed, such as a401(k).

In many situations, you also have the option to select your invested pension money from a few different investment options. This also means that you assume some of your pension's investment risk, and your choices have an impact on the benefits you receive when you retire. You can not decide where to put funds in a pension plan that is fully funded.

b. The implicit rate of return on contributions is one disadvantage of a pay-as-you-go system. If tax rates are stable, a mature pay-as-you-go model will pay a real return equal to the tax base's growth rate, which in the long run is equivalent to the level at which the labor force is rising plus the rate of productivity growth. This has been around 3.2 percent per year over the past 50 years, but this is likely to overstate the growth we can expect over the next 50 years. Social Security benefited from unusually fast productivity growth during the 1950s and 1960s.

Pay-as-you-go pension plans provided by the government do not normally offer many options on the payout side. Recipients are likely to be told when they are considered to be retired and given a few choices on how to receive their retirement payments. On the other hand, private pensions normally allow the recipient to choose a lump sum or monthly payment option for a lifetime upon retirement. If you choose a lump sum payment, the company will cut you a check for the full amount of your pension. You assume full control and then you are responsible for managing your own retirement assets.