Provident Fund vs. Pension Fund: An Overview
Provident funds and pension funds are two types of retirement plans used around the world, but their specifics differ from region to region. Provident funds are prominent in Asia and Mexico, generally operating like Social Security does in the United States.
Pension funds, also known as pension plans or, more specifically, defined-benefit plans, are offered by employers and governments, usually providing a retirement benefit to participants equal to a portion of their working income. There are some differences in how contributions are made and how benefits are accrued; the most significant differences are based on how benefits are paid.
- A provident fund is a retirement fund run by the government.
- A pension plan is a retirement plan run by an employer.
- Pension funds operate much like annuities.
- Provident funds operate more like 401(k) or savings accounts.
A provident fund is a retirement fund run by the government. They are generally compulsory, often through taxes, and are funded by both employer and employee contributions. Governments set the rules regarding withdrawals, including minimum age and withdrawal amount. If a participant dies, his or her surviving spouse and dependents may be able to continue drawing payments. Unlike the U.S. Social Security system, workers in provident funds often only pay into their own retirement account, rather than a group account, so in this sense, a provident fund is similar to a 401(k) account. One key difference, though, is that in a 401(k) account, the account holder makes the investment decisions, while in a provident fund, the government makes the investment decisions.
Members of provident funds are able to take out a portion of their retirement benefits, typically one-third or one-fourth, in a lump sum up-front. The remaining benefits are distributed in monthly payouts. The tax treatment of lump-sum withdrawals also varies between regions, but usually, only a portion of a provident fund's lump-sum withdrawals are tax-free. Pension fund payouts are taxed.
A pension plan is a retirement plan in which an employer, and often the employees, make contributions into a pool of funds set aside for the workers' future benefit. The funds are invested on the employees' behalf, and the earnings on the investments help fund the workers' lives upon retirement. Unlike a provident fund, a pension fund is generally managed by an employer, not the government.
Some pension funds may allow individual participants to choose investments and contribution amounts, while most provident funds have compulsory contributions and centrally-run investments. Unlike Social Security, some provident fund accounts are held in individual names, not pooled into a single trust fund account.
Upon retirement, members of a pension fund can take out as much of their benefits as they would like in a lump sum, though the more common course is to receive monthly payments.
In a sense, the benefits of a pension fund are more like an annuity, while the benefits of a provident fund offer considerably more payout flexibility. The other major difference lies in the compulsory nature of all provident fund contributions.