Provident funds and pension funds are 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.
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. Upon retirement, members of pension can funds 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. 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.
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 the U.S.’s Social Security, some provident fund accounts are held in individual names, not pooled into a single trust fund account.
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.