Provident Fund vs. Pension Fund: What’s the Difference?

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, for example, are prominent in Asia, generally operating like Social Security does in the United States.

Pension funds, also known as pension plans or 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.

Key Takeaways

• A provident fund is a government-backed retirement fund.
• A pension plan is a retirement plan run by employers and governments.
• Pension funds operate much like annuities.
• Provident funds operate like a mix of Social Security and 401(k)s.

Provident Fund

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 up to one-third, in a lump sum up-front. The remaining benefits are distributed in monthly payouts. The tax treatment of lump-sum withdrawals may vary between regions.

Pension Fund

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.

Some pension funds may allow individual participants to choose investments and contribution amounts, while most provident funds have compulsory contributions and centrally-run investments. Pension fund payouts are taxed.

Important

Upon retirement, members of a pension fund may be able to take out their benefits in a lump sum, though the more common course is to receive monthly payments.

What Is the Purpose of a Provident Fund?

A provident fund is designed to create a secure retirement for you. Though some people may not embrace its compulsory requirements, a provident fund’s mandatory contributions take the guesswork out of how much to save.

What Is a Provident Fund in Simple Words?

A provident fund is way to save for retirement. It’s backed by the government. You and your employer put money in so it can grow. Then when you retire, you can take money out, either all at once (up to a point) or month by month.

How Does a Provident Fund Pay Out?

A provident fund may pay out as a monthly payment, similar to an annuity, or as a lump sum. Typically there is a cap on the lump sum payment, such as up to a third of the entire benefit. It depends on the details of the plan.

What Is the Difference Between a Provident Fund and a Retirement Annuity?

Annuities may give you more options for your investments than a provident fund. Also, with a provident fund, contributions are often compulsory. That’s not the case with annuities. And whereas a provident fund is offered through an employer, you can purchase an annuity directly through an insurance company. However, annuities tend to come with higher fees.

The Bottom Line

In a sense, the benefits of a pension fund are more like an annuity, while the benefits of a provident fund are more like Social Security. The other major difference lies in the compulsory nature of provident fund contributions, whereas saving for a pension is not mandatory. Both are low-cost, tax-advantaged accounts.

If you have questions about the ins and outs of your plan, talk to your plan administrator.

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