Defined Benefit Plan
Discuss about the Superannuation contribution in Defined Benefit Plan.
Service sector of economy that is engaged in providing different kind of services (e.g. insurance, banking, education and health) to the people is known as Tertiary Sector. With the onset of this sector people no longer need to worry about the services they require, the gap between the need and its fulfilment is bridged. There is no single service that is provided in this sector. It’s a conglomerate of all kind of services that the society may think of. The employees of this sector are known as tertiary sector employees (Andreasson, Shevchenko, and Novikov, 2017).
The tertiary sector employees are in a motion to get their salaries and along with that some other benefits too. Superannuation contribution is one of those additional benefits. In this a fund is created for the future benefit of employee by deposition of amount by the employer (and employee too through monthly deduction from salary). It is created for their future benefits and their sustainable future at large. It’s kind of a pension plan. The amount gets accumulated in this fund as years roll. Superannuation funds basically are the add-ons which help the employers in improving the performance of their employees as well as providing them with financial security on the end of employment. Different countries have different choices in superannuation funds. Likewise, there are many options made available to employees by Australian Superannuation Funds. Two major choices being: 1) Defined Benefit Plan and 2) Investment Choice Plan (Clark, Fiaschetti, and Tufano, 2017).
Defined benefit plan (DBP) is a fund created by the employer and the amount of fund is promised to be paid to the employee on his retirement either in form of pension or lumpsum or combination thereof. The contributions to this can also be made by employees but that’s rarely observed (usually in public sector). The name itself says DEFINED, which means the way benefit to the employee is to be paid is already known or defined. It nowhere means the benefit is defined (Bateman, Chomik, and Piggott, 2017). The formula for computing the benefit to the employee generally considers the employee’s pay, age at retirement, member’s final salary and years of service. Periodic contribution to this fund is made by the employer and the contribution rate is periodically reviewed by an actuary. The actuary assesses whether the contribution made by the employer is in line with benefits to be paid. Any deficit in the same is to be obligated by the employer (Bikker, 2017).
Investment Choice Plan
Investment Choice plan is also known as Accumulation Plan. In this plan the employers are only liable to pay a certain percentage of the employee’s salary into the fund and after that they are not obligated for any further deposition. The employees under this plan are under a right to get the funds accumulated with additional interest earnings from investment of accumulations thereof. The benefit under this plan largely depends upon the kind of portfolio of investment the employee chooses to invest the amount accumulating into the fund in (Biondi, and Sierra, 2017).
The investment of the superannuation funds is one of the major financial decisions on the part of employees and lies in a vague state for being futuristic and uncertain. Due to a high level of uncertainty involved the employees, naturally are supposed to judge the decision on various parameters even if that’s not related to the final benefit that they will be getting. Each of the investment option has got its own merits and demerits. Every employee has different way of thinking which leads him/her to make a complete analysis of the possible outcome of every investment based on different factors (Park, 2017).
The age of employee is a dominant decision factor. In young age there rests a longer tenure between investment and realisation of benefits. In this case the investor can resist market ups and downs in lieu of higher returns in future. The longer investment period also enables the investor to churn his/her portfolio as per economy and market. This ensures avoidance of stagnancy and higher returns. But if the employee is of old age, he/she may be reaping benefits in near future and couldn’t count on the market movements. So, he/she would want protected and secure benefits even if the returns turn out to be lower (Dean Lee, Ziti, Noh, and Sargent, 2017).
Financial stability is an important factor in decision making process. Generally, employees who are financially proficient are likely to take higher risk and hence are turned to go for Investment Choice Plan. But the employees who are already just earning their bread and butter are not able to experiment much and try to go for secure and defined benefits. Their preferences smirk around Defined Benefit Plans (Andreessen, and Shevchenko, 2017).
Employee Mobility also turns out to be a decisive factor. The employees who are more into changing jobs should opt for Investment Choice Plans as it is an accumulation plan and benefits get accumulated from every employer and there is no erosion of benefits. But in Defined Benefit Plan, frequent job changes lead to opening of different Defined Benefit Plan. Due to this the overall benefit that the employee would have got under a single employee gets eroded (Clark, 2017).
Factors Influencing The Investment Of Superannuation Contribution
The level of information plays a vital role in investment. Greater the information the employees have, greater is there incline towards the kind of investment. Well informed employees are in a better position to take risks than ill informed ones. Gender too makes a difference here. Researches show that men are less risk averse as compared to women, they are likely to indulge in more risky investment practices if it seems profitable (Stannard, 2017). Investment Choice Plans tends to be riskier than the Defined Benefit Plans, as they involve investment options and a portfolio generally is required to be constructed. Earnings in investment choice plan largely depend upon the state of portfolio returns. Similar is the factor of security of benefits. The Defined Benefit Plan provides much more secure benefit because there is less uncertainty in the benefit to be obtained by the employee. Whereas, in Investment Choice Plan, is a large part of benefit solely depends upon market movements. This turns out to be both positive and negative (Boston, and Prebble, 2018).
Many employees even consider how the two investment options have performed in the past i.e. their historical performance (Suroso et al. 2017). It is very basic step before any investment. Past performance is compared for a certain time, say six months, twelve months or more. It is the option performing better in past gets a plus point in comparison over the other. But it’s not same for every employee, one may consider past performance significant and other may not. The employees who have a sound financial knowledge show more tendencies to choose Investment Choice Plans over Defined Benefit Plans (Kelbaliyev, et al. 2018).
Personal interests of the employees also affect the investment decision. The employees who are keenly interested in the market fluctuations are more prompt in choosing Investment Choice Plan as they can actively engage in managing their invested portfolio. On the other hand, the employees who need a stable return without much risk or effort are inclined for Defined Benefit Plan (Chenaghlou, Parizad, and Jafarabadi, 2017).
Time value of money is a basic concept which says that due to inflation and the increased earning potential of future, the value a certain sum of money has now is more than the worth it will have in future. So according to this concept, money lying idle is like a waste asset. But if the idle money is invested properly, it increases it worth in form of interest returns. If we compare the plans based on time value of money, Investment Choice Plan turns out to be a better choice as the money invested therein is earning returns in form of portfolio interest. The accumulations aren’t lying idle. But in Defined Benefit Plan the contributions are to be made equal to the benefit accrued to the employee, which is calculated by using a defined formula that generally considers age of employee, tenure of employment, salary drawn etc. so according to time value of money, the funds in Defined Benefit Plan generate no further earnings once contributed into the fund (Santos, et al. 2017).
Effect Of Time Value Of Money, Taxes
Taxes refer to the compulsory payment that is to be made to the government authorities on any income earned or any gain made. Taxes are to be paid without any expectation to get something in return. In case of both the plans accept some situations (on death of employee, employee becoming incapacitated to perform etc.), tax is deducted when pensions are paid on retirement. In case of Defined Benefit Plan the tax, deduction is limited to the amount of contributions into the fund as there lay no additional earnings on that amount. But if the Investment Choice plan is observed, the accumulations get summed with the investment earnings. Here, the investment earnings are also bound to be taxed and are to be disclosed also. This calls for more compliance and disclosures. This sometimes becomes the reason of aversion to Investment Choice Plans (Bowen, 2018).
Every employee who is deciding to undertake an investment strategy to create value on their investment related to whether to place their superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan should consider the time value of money. It assists them to overcome the risk of money value loss (Chandra, 2017).
There should proper comparison between the available investment options by the territory sector employees before investing their capital in particular projects.
The investment plan giving higher return and less risk should be accepted by the territory sector employees.
The Risk and return of the undertaken superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan should also be assessed by the investors before investing their capital in particular investment projects (Khodaei, 2017).
Conclusion
Tertiary sector holds major part of economy and solely lies on the performance of its employees. So, to boost the employees’ various benefits apart from salaries are provided and the employees are set free to make their choices. Superannuation fund investments become an important decision for the employees and hence affects by many factors, a few of them as discussed above. Many improvements are being made in the schemes and investment plans from time to time for smooth operation. Now in the end, it could be inferred that risk and return associated with the plan should be assessed by the investors before investing their capital in particular investment projects.
References
Andréasson, J.G. and Shevchenko, P.V., 2017. Assessment of Policy Changes to Means-Tested Age Pension Using the Expected Utility Model: Implication for Decisions in Retirement. Risks, 5(3), p.47.
Andreasson, J.G., Shevchenko, P.V. and Novikov, A., 2017. Optimal consumption, investment and housing with means-tested public pension in retirement. Insurance: Mathematics and Economics, 75, pp.32-47.
Bateman, H., Chomik, R. and Piggott, J., 2017. Retirement income. In Ageing in Australia (pp. 149-172). Springer, New York, NY.
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Biondi, Y. and Sierra, M., 2017. Pension management between financialization and intergenerational solidarity: a socio-economic analysis and a comprehensive model. Socio-Economic Review, p.mwx015.
Boston, J. and Prebble, R., 2018. The role and importance of long-term fiscal planning. Policy Quarterly, 9(4).
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Chenaghlou, M., Parizad, R. and Jafarabadi, M.A., 2017. Risk Factors and Prevention of Pulmonary Embolism in Young Adults. Crescent Journal of Medical and Biological Sciences, 4(1), pp.7-12.
Clark, G.L., 2017. 15. The financial legacy of pension fund capitalism. Handbook on the Geographies of Money and Finance, p.348.
Clark, G.L., Fiaschetti, M. and Tufano, P., 2017. Advice in Defined Contribution Plans. Financial Decision Making and Retirement Security in an Aging World, p.96.
Dean Lee, M., Zikic, J., Noh, S.C. and Sargent, L., 2017. Human resource approaches to retirement: Gatekeeping, improvising, orchestrating, and partnering. Human Resource Management, 56(3), pp.455-477.
Kelbaliyev, G.I., Mammadova, G.M., Samadli, V.M., Talibov, N.H. and Samedov, M.M., 2018. Theoretical and Experimental Investigation on Granulation Processes of Powdered Materials in Cylindrical Granulator. J Chem Appl Chem Eng 2, 1, p.2.
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Santos, S.F., Fitiwi, D.Z., Bizuayehu, A.W., Shafie-Khah, M., Asensio, M., Contreras, J., Cabrita, C.M. and Catalão, J.P., 2017. Impacts of operational variability and uncertainty on distributed generation investment planning: A comprehensive sensitivity analysis. IEEE Transactions on Sustainable Energy, 8(2), pp.855-869.
Stannard, J., 2017. Reshaping the default fund process. Superfunds Magazine, (423), p.10.
Suroso, E., Satyajaya, W., Utomo, T.P. and Julianti, L., 2017. Financial Feasibility Study of Liquid Smoke Industry from Palm Oil Empty Fruit Bunch in Mesuji Regency, Lampung Province. INSIST, 2(1), pp.23-26.
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