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What Is a Pension Trust Fund?

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  • Written By: John Lister
  • Edited By: Kristen Osborne
  • Last Modified Date: 13 July 2014
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A pension trust fund is a combined pool of money from from both an employer and its employees that is designed to fund future payments to the employees. It is usually used for pensions that are primarily provided by the employer rather than saved for by the employee. The trust fund operates under relevant national laws that govern how the money is controlled and allocated.

There are two main types of pension plan in most countries. A private pension plan involves an individual, usually an employee, saving in a private plan operated by a financial company. The most common example of this in the United States in the Individual Retirement Arrangement. The only involvement an employer has with the plan is to deduct money from the employee's wages and send it to the plan and, in some cases, to contribute extra money to the plan as a form of employment benefit.

The second type of plan is the company pension plan, where the entire process of savings, investment, and pension provision is controlled by the employer. Usually this is done through a pension trust fund. The employer acts as a trustee and holds money on behalf of the settlor, which is the employee. Although the trustee has legal control of the money, the rules of the trust fund forces them to act in the interests of the settlor and follow agreed procedures.

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One major benefit of this type of trust fund is that it allows money from the pension savings of multiple employees to be pooled together for investment. This can reduce administration costs. It can also give more bargaining power to the fund's investors, meaning they may be able to buy or sell investments at more favorable rates.

The other main benefit of a pension trust fund is that it protects the savings. In theory, the employer will not be able to use the money in the fund for its own purposes. In practice, this has happened in some cases and many countries have brought in tighter regulations to prevent abuse.

The biggest drawback of a pension trust fund, and company pensions in general, is that many such plans guarantee to pay a certain level of pension, often based on the employee's salary upon retirement. This is in contrast to most private plans, where the pension depends on how well investments perform. This creates the risk that a pension trust fund may not have enough money to pay the guaranteed pensions if investments do not go as well as planned. In some cases, the set-up of a pension trust fund relies on the money invested by current employees to provide the pensions of people who have retired. This can be problematic if demographic changes, such as the "baby boomers" reaching retirement age, creates an imbalance between employees and retirees.

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