Defined Benefit Plan for Retirement
What do you think are the important factors that should be considered by tertiary sector employees when they are deciding whether to place their superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan? What issues relating to the concept of the time value of money, taxes etc., might be important in this decision-making process? Explain.
The current study is about the assessment of superannuation funds and the most appropriate type of retirement plan for the tertiary sector employees. The study will do research and findings on retirement plans for facilitating the employees in making best retirement decisions. Along with this study will also cover the factors that are required to be considered before making investments in a particular retirement plan. Furthermore, there is two type of retirement plan in which an employee can choose or invest which are Defined benefit plan and defined contribution plan. Since, there is the high importance of gaining a better understanding of this plan while making an investment, as these plans are very beneficial and useful in future. These both plans are briefly analyzed and described in the current report; this will help the employees in choosing the plan in accordance with their expectancy, interest and interest and proficient and competence need. Furthermore, the study also covers and discusses the impacts of the time value of money theory, taxes and inflation on the retirement plans and decisions.
Defined Benefit Plan
Defined Benefit plan offers employees a plan with a benefit which is a known amount. The further employer, as well as the employee, might make a contribution to the plan; along with this, the employer is liable for any shortfall in contribution while ensuring guaranteed pension benefits. It takes place in two varieties which are traditional pensions as well as cash-balance plans (Topa, Lunceford and Boyatzis, 2017). A defined benefit plan is also called as a pension; it is a promissory account for retirement by which the employer integrates all the money deposits and ensures a set payout at the stage of retirement. Under this plan, a fixed and pre-set benefit is formed by the employer for employees. Generally, the employee does a valuation of fixed benefit offered. While the employer, a business can make a contribution to the plan and thereby deduction every year. On the other hand, this type of retirement plan is complex yet costly to create and manage as compared to another type of plan.
Defined Contribution Plan for Retirement
A defined benefit plan determines the particular benefit that will be paid to retire at the retirement (Clark and Newhouse, 2016)t. Further, the retirement benefit is based on a given formula that considers factors such as the working length of the employee, i.e., years of service and the salary history of the employer.
Investment Choice Plan
A defined contribution plan, make no promises for a specified amount of benefit at the stage of retirement. It is a retirement plan wherein both employers as well as the employee makes a contribution on a frequent basis. Own and personal accounts are created for the employees and benefits are totally based in on credit amount on the account through the contributions of the employee, along with earnings of investments on the deposited account (Sialm, Starks and Zhang, 2015). In this plan, fluctuations of future benefits are based on investment earnings. Investment choice plan means a savings plan based on tax-deferred that individuals financed with their individual’s money instead of employers and utilized to secure for retirement stage. The investment choice plan is a characteristic offered by a lot of superannuation funds; this allows participants of super funds to make decision and choice on the investment for their super money.
Factors that should be considered by tertiary sector employees for retirement planning
There are multiple factors affecting the benefits that cover the employee’s benefit from the employer-sponsored retirement plan. In the side of definite benefit plan, the factors that can impact are inclusive of benefit formula, service length, pre-retirement earnings and retirement age (Rejda, 2015). On the side of investment choice plan, the factors are inclusive of investment earnings and contribution amounts.
In any retirement plan, the more early an employee retires, the much smaller the benefit they will get. In the investment choice plan, the retirement benefit is limited to the worth of the participant account (Drucker, 2017). In a situation where an employee retires at an earlier stage, then they will not be able to attain further contributions. The retirement plan sponsored by the organization is either defined benefit or defined contribution.
The money earned on the type of retirement plan has a main impact on the retirement benefit. By considering the defined benefit plan, the employer is generally liable for the contribution of sufficient money in their account to the made payment of defined benefit at the phase of retirement (Beehr and Bennett, 2015). The defined benefit plan, the entire retirement plan is employer-sponsored, and the associated risk and management of portfolio are completely borne and controlled by the organization.
Factors That Affect Benefits of Retirement Plans
There are some of the factors that can have a direct and indirect impact on the contributions which are higher payment than expected, lower return on investment than expected, lower interest rate than expected, changes in the requirement of federal and recruitment of new employee (Henretta, 2018). In addition, employees must also consider their future goals, wherein they must consider that whether their financial obligations and targets are satisfying or not. Along with this, employees must also consider their future expenses alongside, on the basis of this they must make a decision whether they want the pension in lump-sum or in instalments.
Time value of money
The time value of money is the most basic and integral theory in financial aspects and depicts that a dollar is highly worthwhile today as compared to the dollar of at a later date. It is because the dollar can be now invested in order to gain interest on the dame, and the earned interest can be put on reinvestment to gain more interest, and the process will be continued to earn higher returns which are known as compounding interest (Findley and Caliendo, 2015). This concept is vital while planning for retirement; it is because when the retiree makes a decision of investment is probably the most significant aspect in the size of their nest egg at retirement.
The concept of time value is applicable to every area of financial planning and can be implemented while identifying capital budgeting. Further, it is a crucial element of capital budgeting and the NPV approach, as it picturizes a better image in front of investors about the returns and benefits on investment and retirement plans. Particular differences of TVM of money computation are Net Present Value, Present Value and Future Value.
In accordance with the time value of money concept, money is entirely based on time; the earlier an individual will invest the money, the more valuable and beneficial the investment money will (Earl, Bednall and Muratore, 2015). It can be seen as; if the money is invested now by the employee, then they will be entitled to earn interests or returns on the invested money. Further, it can be said that money must be invested as soon as possible to enjoy further benefits.
Below is represented an example of the time value of money:
Savings Value of retirement in future |
|||
Monthly Savings |
10 years |
15 years |
20 years |
$25 |
$1500 |
$7500 |
$12000 |
$100 |
$7000 |
$29000 |
$46500 |
$250 |
$17500 |
$75000 |
$115000 |
Taxes
Taxes are the most significant aspect to be considered, and it matters the most for the retirees at the retirement. Taxes are the one conviction of planning that can act as a barrier while progressing towards the ultimate objective. With effective planning for tax, and making use of appropriate tools, employees can be able to minimize the effect of taxes on their retirement funds. It is essential for the employee to consider the impact in long-term saved retirement funds, facilitated by TVM theory by which they can save more and more money (Brown, Cederburg and O’Doherty, 2017). Moreover, employees must examine the increase in tax and other factors while making savings for retirement. Along with this, the employee must be well aware of taxation sources and make use strategies to put a stop on the spending cycle on taxes. The amount obtained as superannuation fund is exempted from tax obligation, in case the amount is payable to an employee in the event of death, in against of or as annuity and retirement.
Time Value of Money and Retirement Planning
The compounding power has a great effect on taxes. It is significant for the employee to make use of investment accounts which are sponsored by the government like IRAs highly while conducting the retirement plan, as they will generally afford the benefits of tax-deferred payments (Dalton, Dalton and Cangelosi, 2016). It is important for the employee to save as much as for retirement and as soon as possible while taking full benefit of available tax related opportunities.
Inflation
Inflation affects every type of retirement plan, and it has a larger impact on long-term workings and savings, so it is essential to adjust the savings in order to prevent the impact of inflation which can decrease the value of saved money. Inflation affects in making a reduction in purchasing power, as when the prices for products and services increases rapidly than the deposited money in the account, then the money will have the value to but lesser and lesser products and services over the period of time (Hanna and Kim, 2017). Thus, an investor is required to sure to have enough retirement income in order to satisfy own expenses. Moreover, inflation also consumer the savings or deposits rapidly, while identifying the yearly retirement budget, one needs to effectively adjust the funds and associated costs to make sure that investor has enough money to satisfy their financial targets and goals.
Inflation is the factor which must be given high consideration while saving money for retirement, as this risk can threaten the secured money in near future. This affects the money by reducing its value, by considering this aspect tertiary employees must consider the risk of inflation before making an investment in a retirement plan (Wakeman, Tashman and Yan, 2016). Appropriate measures must be taken into account so as to ensure anti-inflation pension plan.
Other related factors
Risks: Risk variable in the Defined benefit plan is less or no, it is because the risk is bear by organization or employee as the plan is sponsored by them. Further, in defined benefit plan the risk is relatively low, but it required effective planning and strategies in order to prevent risk is arises. Employees who do not want to face any risk with their plan, then they must choose defined benefit plan as this will ensure in properly safeguarding their deposits and pensions (Wang and Shi, 2014). On the other hand, the investment choice plan has associated risk, as the contribution of the plan is based on the employee, and also employee is unknown about how much benefit they will get in future. The plan is also entitled to tax, and the employee is not aware of the fact whether they will receive the desired benefit or not.
Taxes and Retirement Planning
Investment earning and progress:
The performance and earnings on investments are also essential factors to be considered, to know that the invested money is worthwhile or not. This can be done by considering the benefits and progress of the plan; if the investment seems beneficial, then the investor must carry on the same process (Beshears and et al., 2015). On the other hand, if the investment seems non-effective, then the investor must stop making more investment in the plan, rather than this they must choose another option to secure their life savings.
On the basis of the present study, the conclusion can be drawn that both the plans are best in their own way, but it the based on the willingness of the employee to choose one of them. However, according to the study, it can be suggested that tertiary employees must go for defined benefit plan, as the amount is fixed and the employee knew how much benefit they will receive and the most important thing it is risk-free.
References
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Wakeman, L.K., Tashman, A. and Yan, F., FINMASON Inc, 2016. Systems and methods for retirement planning. U.S. Patent Application 15/075,613.
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