Financial Feasibility Of Delaying Social Security

Investment Plans

Discuss about the Financial Feasibility of Delaying Social Security.

All the three sectors of an economy have a defined time period for the services of their employees. After completing the services period everyone needs money to live a healthy and wealthy life even after their service period. For this they need a continuous income for the rest of life, in this order employees make some investments in different investment schemes or plans. Some of these investment plans are made by the employer specifically for their employees and some are made by the business organizations which are need to be selected by the employees individually. This report consists of the description of defined benefit plan and investment choice plan. Report also consists of the different issues associated with these plans related to the time value of money and taxation. The tertiary sector employees needs to analysis the tax exemption, interest rate and return available on the investment options. If the tertiary employees are having mind set to entertain high risk in their investment option then investment choice option would be more beneficial for the tertiary employees.

A systematic investment plan is the one in which investors make a regular payment of predefined amount into a trading account, retirement account, or in a mutual fund depending on their suitability for the return schemes of the respective plans, and benefits the long term advantages of the dollar-cost averaging that involves buying of a fixed dollar amount as the security regardless the price variations. Investment plans are made for the convenience of employees for the regular savings without any extra effort except the initiation of the systematic investment plan. For making funding payments and buying new shares as well for the investment, a money market account or some other liquid account is used.

This is the third segment of economy which provides services to their customers instead of the end products. The services of this sector include advice, access, attention, experience, and discussion etc. This industry is further split into two categories as profitable segment and other one is non-profit segment. Profit segment consists of the businesses making money like financial industry whereas the non-profit segment consists of businesses which include services like state education. Employees of this particular sector are called tertiary employees as they provide their services for the tertiary sector of the economy. Financial industry deals with the financial aspects for the need of individuals in present as well as in future. Individuals use investment as an asset with the ultimate goal of generating future income. For these employees, there are many options for the investment in order to generate their future income. This income will help them in their future to live a healthy and wealthy life even after the completion of their service period.

Tertiary Sector

Defined benefit plans are defined as an employer sponsored plan for the retirement of the employees. Moreover, a benefit plan can also be defined as a pension plan which provides benefits to the employees after their retirement based on their salary amount or typically a predefined percentage of their salary for each year of their service to the company. In these benefit plans the employee benefits are calculated using different formulas which consider various factors like, length of their employment time period, salary history, their professional record in the organization etc. Defined benefit plan or pension plans are called defined just because the benefit computation formula for the respective plan is known to both the employee and employer as well, ahead of the time. This plan is slightly different from other benefit plans as the pay-out amount of other investment plans depends on the investment returns whereas defined benefit plan guarantees a specific pay0out or benefit at the time of retirement. Since employers are responsible for investment decisions as well as the management of the investment plans, they consider all the investment risks associated with the respective plan. In this decision making process, an employer may opt for a fixed benefit amount or the amount calculated using the formula which factors in age, average salary,  and time period of the service. The investment of this plan is made by the employer himself by contributing a defined amount or percentage of the employee’s earnings. However, depending on the design of plan, employees may contribute an additional amount as an investment in the same plan.at the time of retirement, returns of the plan may be paid-out in monthly payments throughout the lifetime of employee or as a one-time payment (Parke, et al. 2018).

An investment choice plan can be defined as a plan which modifies regularly depending on the market scenario at the particular time. This choice plan is completely different from defined benefit plan as in this plan employees select their investment plan according to their suitability for the particular investment plan among all the investment schemes available in the market. This plan is the transition of defined benefit plan as initially defined benefit plan was introduced. For the selection of any investment plan employee is the decision making authority for the same. If the tertiary employees want to invest in particular investment choice then they needs to analysis all the positive and negative factors, associated risk and return available to investors (Julius Giarmarco, 2017).

Defined Benefit Plans

Returns are the gains or losses of the investment securities in a particular time period. These returns are associated with different market risks, which may influence the total amount of return for which the investment was made initially. Defined benefit plans are now transiting into defined contribution plans where many risks are associated with the returns of investment. Benefits plan also have some issues related to the concept of time value of money, taxes, inaccurate and estimates. These investment issues could be mitigated by following proper investment program and using capital budgeting tools and technique (Kerzner, and Kerzner, 2017).

Defined benefit plan is primarily associated with the issue of inaccurate estimation of employee’s pension benefit obligation (PBO). PBO represents the present value of the liability of employee’s pension benefit in the future. In case of the defined benefit plans the estimation of the benefits is made only once at the beginning but in investment choice plans this estimation of return benefits revised with each modification or change in the plan, depending of the market scenario. This ensures a correct estimation of benefits in case investment choice plans. Most of the time, investment made in the choice plans is more beneficial as the regular revision of the interest rate increases the worth of money provided by the investment returns in future (Stiff, et al. 2014).

The concept of time value of money states that the value of money available at the present time is more worthy than the identical sum that will be available in future and that is just because of the potential of earning capacity of the money available at present. As the core principle of finance states that the provided money can earn the interest, therefore the amount of money is worthy more the sooner it is available or received. This concept of the time value of money is drawn from the idea that rational investors prefer receiving their money today rather than receiving the same amount of money in future (Aggarwal, and Goodell, 2015).  This concept also defines the future value of the same money investors receive today using a fundamental formula for the computation of future value of the money. This formula takes into account some variable which may slightly change depending on the situation of the question. Fundamental variables of this formula are present value of money, interest rate, number of compounding periods per year, time period in years. Using these fundamental variables the formula is given as (Sialm, Starks, and Zhang, 2015).

Investment Choice Plans

  FV = PV*[ 1+( i / n) ]^{( n * t )}

This factor of time value of money influences the benefits of different investment plans depending upon the inflation rate of the country. The impact of inflation rate on the benefits depends on the type of investment plan selected. Like, if the investment is made only into the stocks then this would be beneficial for the returns as historically stocks have been good for the returns against the inflation rate (Stefanescu, et al. 2018).  Whereas, defined benefit plans have a drawback of higher inflation rate as the future value of the money will be less than the present value of the same amount of money. Therefore, in this context investment choice plans are better than the defined benefit plans as the inflation increasing inflation rate decreases the future value of the money in defined benefit plans (Goda et al. 2017).

Taxes are the fee charged on the different assets of the individuals or corporations enforced by the government to finance the various government activities. For this tax planning is done which analyses the financial situation and plan for the savings or securities from a tax perspective. Main motive of tax planning is to ensure the tax efficiency for the savings (Brinch, Hernæs, and Jia, 2017). The amount of tax exemption depends on the investment plan tax exemption is exceptional in case of defined benefit plans as there is a complete tax exemption for the investments made in this plan whereas the other investment choice plans are considered for the tax fee. This tax fee in these plans is less in comparison to the tax paid for the direct income. Therefore, in terms of taxation defined benefit plans are way more worthy than the other investment plans (Settersten Jr, 2018).

Tertiary employees working in financial industry know how to save their tax. For this they make investment in different investment plans which provide an exemption of the tax. Therefore, Tertiary employees should accept the investment choice options to have the more tax benefits on their investment. In case if the return offered under the defined investment plan is less then Tertiary employees should invest their capital in investment choice plan.  The risk, return, tax exemption and lock in period are key factors which should be analyzed by the Tertiary employees before investing their capital in particular investment project or defined benefit plans (Zhou,  Chow,  and Xu, 2017).

Conclusion

After analysing all the detail and case study, it could be inferred that if Tertiary employees working in financial industry are more inclined towards investing their capital in the investment choice options. On the other hand, if Tertiary employees who do not have knowledge about the finance are less inclined towards investing in highly risky investment option and put their capital investment in defined investment plan. Now in the end, it could be inferred that if Tertiary employees finds that the market is offering more return with less risk then they should invest their monthly contribution in defined benefit plan.

References

Aggarwal, R. and Goodell, J.W., 2015. Determinants of expected returns at public defined-benefit pension plans.

Brinch, C.N., Hernæs, E. and Jia, Z., 2017. Salience and social security benefits. Journal of Labor Economics, 35(1), pp.265-297.

Goda, G.S., Ramnath, S., Shoven, J.B. and Slavov, S.N., 2017. The financial feasibility of delaying Social Security: evidence from administrative tax data. Journal of Pension Economics & Finance, pp.1-18.

Julius Giarmarco, J.D., 2017. The three levels of family business succession planning.

Kerzner, H. and Kerzner, H.R., 2017. Project management: a systems approach to planning, scheduling, and controlling. John Wiley & Sons.

Parke, M.R., Weinhardt, J.M., Brodsky, A., Tangirala, S. and DeVoe, S.E., 2018. When daily planning improves employee performance: The importance of planning type, engagement, and interruptions. Journal of Applied Psychology, 103(3), p.300.

Settersten Jr, R.A., 2018. Rethinking social policy: Lessons of a life-course perspective. Invitation to the Life Course: Toward New Understandings of Later Life. Baywood, Amityville, New York.

Sialm, C., Starks, L.T. and Zhang, H., 2015. Defined contribution pension plans: Sticky or discerning money?. The Journal of Finance, 70(2), pp.805-838.

Stefanescu, I., Wang, Y., Xie, K. and Yang, J., 2018. Pay me now (and later): Pension benefit manipulation before plan freezes and executive retirement. Journal of Financial Economics, 127(1), pp.152-173.

Stiff, G., Sharpe, M. and Atkinson III, L.W., Genworth Holdings Inc, 2014. System and method for imbedding a defined benefit in a defined contribution plan. U.S. Patent 8,799,134.

Zhou, Y., Chow, N. and Xu, Y., 2017. Socialist Welfare in a Market Economy: Social Security Reforms in Guangzhou, China: Social Security Reforms in Guangzhou, China. Routledge.