Pension funds – how do they work and why is their popularity rising?
14 OCT, 2025
Pension funds, as the name itself suggests, are institutions that collect and invest contributions from citizens to provide them with financial security during retirement. The popularity of private pension funds has grown significantly, not only due to the desire for higher returns but also because, in countries where public retirement systems fail, they often represent the only way to ensure a decent standard of living in older age. The system we know today has its origins in the 19th century, specifically in 1889 in Germany, on the initiative of Otto von Bismarck.
Pension funds operate differently depending on their type. They all rely on collecting regular contributions from participants. Upon reaching a certain age or length of service, the accumulated funds are disbursed to the participant. The final amount may vary depending on the fund’s structure and investment performance, from much less to much more satisfying.
In some countries, contributions are used for current pension payments – meaning the contributions of today’s workers fund the pensions of current retirees. In other countries, the money is invested by the state in private funds (e.g., the AP Funds in Sweden).
Types of pension funds and their characteristics
Based on the organization of the pension system
- Mandatory (public) – created within the framework of a state-run pension system
- Voluntary (private) – additional forms of savings
Based on financing and structure
- Defined Benefit (DB) Funds – the future pension amount is predetermined (e.g., a percentage of the last salary), and investment risk is borne by the managing institution.
- Defined Contribution (DC) Funds – the pension amount depends on the sum of contributions and investment returns; the risk is borne by the participant.
Based on legal form
- Open Pension Funds – available to anyone meeting statutory requirements.
- Occupational Pension Funds – created by an employer for employees.
- Individual Savings Plans – voluntary retirement savings accounts that allow individuals to save for retirement independently.
Based on investment strategy
- Conservative/Safe Funds – invest mainly in bonds and fixed-income instruments.
- Balanced Funds – a mix of bonds and stocks.
- Aggressive Funds – high proportion of stocks, higher risk, potentially higher returns.
- Life-Cycle / Target-Date Funds – investment strategy automatically adjusts according to the participant’s age (the closer to retirement, the higher the bond allocation).
Global growth and popularity of pension funds
According to the OECD, pension assets have grown significantly over the last two decades. In advanced economies, pension assets have nearly doubled as a share of GDP to an average of 55%, exceeding 100% of GDP in eight countries. In March 2024, the board of the United States’ largest public pension fund endorsed a strategy to increase its investments in private markets by over $30 billion.
The Government Pension Fund of Norway is now the largest in the world, overtaking Japan’s GPIF after over 20 years as the global leader by assets.
Why are pension funds so popular?
Aging populations
People are living longer, and the number of workers relative to retirees is decreasing. Pay-as-you-go public pension systems are becoming harder to sustain.
Greater financial awareness
Over time, people have become more aware of the need to diversify savings and secure their financial future in a balanced way.
Government policies and tax incentives
Many countries provide tax benefits or contributions to private pension funds (e.g., PPK in Poland, 401(k) in the USA).
