Explain the main difference between the pay-as-you-go system employed

Explain the main difference between the pay-as-you-go system employed by Social Security and a private pension plan.

What will be an ideal response?

ANSWER

Superficially, the two systems look the same. Individuals pay money now in order to receive benefits in the future. The pay-as-you-go system, however, merely takes the contributions from current contributors and uses them to pay current retirees. In that way, the Social Security system is unfunded because without new contributions from current and future workers, benefits could not be paid today and into the future. A private pension plan, on the other hand, takes contributions from individuals, invests them, and pays the individual’s retirement benefits out of the individual’s contribution. Thus a private pension plan should be fully funded in that the pension plan will have a fund of past contributions and interest out of which current benefits are paid.