Final answer:
Fully funded retirement systems are based on individual contributions that are invested to fund retirement, while pay-as-you-go systems rely on current worker contributions to pay for current retiree benefits. Demographic shifts challenge the sustainability of pay-as-you-go systems, whereas defined contribution plans like 401(k)s allow for individual investment growth.
Step-by-step explanation:
The fully funded and pay-as-you-go systems represent two fundamental approaches to financing retirement benefits. In a fully funded system, the contributions made by or on behalf of an individual are invested to provide retirement benefits solely from the investment returns on those contributions. By contrast, a pay-as-you-go system relies on the current workforce's contributions to fund the benefits of current retirees.
Demographic factors play a crucial role in the viability of the pay-as-you-go systems. When the population is younger, with more workers than retirees, the system remains stable. However, with demographic shifts such as the aging of baby boomers in the United States, the ratio of workers to retirees decreases, leading to sustainability challenges for programs like Social Security and Medicare. This imbalance requires reforms to ensure long-term viability.
As contrast to these traditional pensions, people are increasingly relying on defined contribution plans such as 401(k)s and 403(b)s. Here, both employers and employees contribute a fixed amount to retirement accounts, which are then invested. These funds are tax deferred and carry the potential for investment growth, shielding retirees from some of the inflation risks inherent in the traditional pension system.