government earning the interest. Yeah. AUDIENCE: Can you earn interest on a pension? PROFESSOR: OK. So let's come to that. Let me make sure people understand the math here and why it's a better deal. OK. Do you earn interest on a pension. It's a good question. There is three ways that you can have tax subsidized retirement savings. And let me go through them clearly now. One route is the pension. Under a pension, your employer takes money out of your salary, saves it in some account with your name on it, but they invest it. And then you get the money when you retire. An alternative, which firms are slowly moving to, is 401(k) accounts, which you've all heard of by now. 401(k) accounts are just like pensions, except you control the investment of the money, not the firm. So under a pension account, your employer takes money out of your salary, puts it aside, and invests it as he likes, and you get the return when you retire. A 401(k) account is the same thing except you decide how much to take or the employer decide how much to take, and you decide how to invest it. And then you get the return at the end of the day. But the tax treatment is the same. Yeah. AUDIENCE: Isn't it also one's defined benefits and one's defined contribution. PROFESSOR: Well, within this, within pensions, there's two kinds of pensions. There's defined benefits and defined contributions. We can think of this as old style and new style. Defined benefits is what the auto companies and the steel companies had. It's dying away. A defined benefit pension is one where you don't actually get an account from your employer. They just take money out of your salary. And then when you retire, they pay you some amount which is unrelated to what you put away. It's related to something like how long you worked at
the company and what your wages were. So defined benefit pension is they literally define the pension benefit you get. And it's got no direct relation to how much money they took away on your behalf. It's related, instead, to what you earned and how long you worked there. A defined contribution pension is what I described. It's literally an account with your name on it. And that's what most pensions are now. Almost any firm you guys will work for will have a defined contribution pension, which is one where there's literally an account with your name on it. And most of you will have 401(k)s where you actually control the investment. And then finally, the last option is IRAs. That's not the Ireland thing, but individual retirement accounts. These are accounts which operate outside the employment setting. You can literally set up your own pension, effectively, by taking money, putting it in the bank, and calling it an IRA. The thing about IRAs is IRAs are not special investment vehicles. They're just a label for savings that you do.
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- Summer '17