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 present study evaluates and analyses Defined Benefit and Investment Choice plan, for assisting the employees in choosing the best suitable plan as per their need. It is totally based on the employee, whether they want to either choose Defined Benefit or Investment Choice plan; however the study makes it simple for the employees in getting a better understanding of both these plans. Along with this, the study also assesses the impact of the time value of money and taxes on the superannuation funds.
Retirement planning means the assigning of savings for retirement phase. The objective of retirement planning is to accomplish financial targets and independence. It is a process of managing and planning employee’s both short-term as well as long-term funds to aid them in achieving their financial targets in working years as well as on retirement (Thorp and et al., 2017). It is engaged in analysing employee’s financial goals, existing financial position and potential cash flow in order to develop a detailed retirement insight and roadmap.
In addition to this, a retirement plan possesses several benefits for the employee; this enables the employee to make an investment in their financial security when they reach the stage of retirement. For bonus points, employees are also entitled to considerable tax benefits and other incentives.
The employee gets multiple benefits from retirement planning, wherein the contributions made by an employee can make a reduction in existing taxable income, plus these contributions and return on investment are not entitled to tax unless and until these are distributed. Along with this, contributions are facilitated to make payroll deduction and compounding interest over the period of time, and it enables little regular supply of contributions to developing a considerable retirement savings (Donald and Le Mire, 2016). By this retirement assets can be conducted by an employer to other, plus there is the higher accessibility of saver’s credit. Furthermore, the employee has a great platform to make improvement financial security during retirement.
There are two types of retirement plans which can be selected by tertiary sector employees for their retirement planning which are defined benefit plan and investment choice plan. The description of same is provided as below:
A defined benefit plan fixes the benefit of an employee in advance, generally as a percentage of the earnings of an employee at their retirement. For example, a defined benefit plan, as per assumption provides a retirement allowance of 1 % of the total earnings per year. When the employee is at the retirement stage after 40 years, then the employee will get an allowance of 40% of their earnings on the pre-retirement basis. In the defined benefit plan, the employee cannot know how overall plan will cost; also there is the difference in contribution rates, based on the results of the standard reviews (Peng, 2017). Further, the employees can forecast the overall benefits which they get as the percentage of their earnings before the stage of retirement. In the DB plan, the higher the return on investment is, the lower will be the rate of contribution. However, in case the investments are not effective, then the contribution rates are required to be increased to offer the promised benefits. The overall cost of purchasing a retirement pension can also impact the contribution rate.
An investment choice plan possesses a set contribution plan for the employee as well as the employer. For instance, in most of the investment choice plan, both employer and employer will make a contribution of 5% of the total earnings of employee, or total of 10%. Further, these contributions are put into investment purposes for the support of every member engaged in the plan. The benefits of retirement for the employee will be based on the total deposits of money by retirement, and it is impossible to know the pension benefits in advance (Cummings, 2016). Further, investment choice plans are comparatively immature that is they have faced comparatively a low amount of retirement, several issues and might take place in due course. On the other hand, the main factor is the sufficiency of payment of pension benefit on retirement in the investment choice.
Compound interest: turning out to be a good saver is the core element of gaining success on a retirement plan. Through constant contributions in the retirement plan sponsored by employer and IRA, the employee is able to maximize compound interest power, in which the interest is gained on the first principle as well as on accumulated interest on earlier dates (Gerrans and et al., 2016). With ongoing contributions, employee retirement savings have a higher possibility of accumulating to satisfy long-term financial goals.
Personal Savings: By taking the impacts of inflation into account, there are higher chances that employee’s retirement plan return might shortfall the needs, particularly long duration retirement. Generally, social security offers a better base for planning retirement (Cheah and et al., 2015). Therefore, in order to prevent a possible shortfall, it is essential for the employee to do strategic planning for supplementing their retirement income with individual deposits and savings.
While interpreting these standards there is no assurance of future success; employees can get the chance to choose the appropriate roadmap (Kireeva, 2016). The earlier the employees realize the impacts of economic factors, the sooner they will be able to implement strategies that can assist them in achieving their financial retirement objectives. In the present era, employees are required to become proactive to increase their retirement planning for future.
For the employees, having less or no capacity to bear risk or their financial status reflects that they are not in a position to bear the risk, then they must select defined benefit plan due to comparatively low risk (Grable and Carr, 2014). On the other hand, if the employee risk-bearing capacity is high and their financial status reflects that they are in a position to bear the risk, then they can undoubtedly choose investment choice plan.
Time value of money
Core theory of finance is based on time value which means that money which exists at the present time has more value than the same in future. Potential earning capacity is the base of same. The worth of money can be increased as interest can be earned over time, but it has more of its value in the present (Xingyun, 2015). It is considered useful financially for having some amount of money and expend it directly the reason behind this is an increase in inflation rate can decrease the purchasing power of the same amount. It is applicable to all parts of financial management can be utilized at the time of capital budgeting. It’s a crucial element of capital budgeting and net present value approach as it offers an accurate picture of benefits and returns to the financial managers that they resolve on capital projects and investment prospects.
Planning
Planning for retirement is lifespan process. It is the duty of employees to make sure that retirement portfolio earns from the investment which makes them happy (FroidevauxS, Hirschi and Wang, 2016). It further specified that the employee need is to continue abreast of trends; tips and long-term investment choices which help them in reaching their financial objectives.
Risk Mitigation
Target retirement funds are one of the best alternatives since they involuntarily change risk based on age and relative distance to retirement age (Muratore and Earl, 2015). To set up employer-sponsored plan employees frequently utilize risk assessment tool, but it is unsuccessful in retaining these settings. It creates risk mutually in account rebalancing and also in age-risk correlation.
Inflation
1% increases in inflation hardly close an eye in one year. If it does not stop for another 20 years, then our purchasing power which was planned, i.e. $60000 will fall to $49000. It is assumed that inflation rate should not be rise from more than 1%. It is important to save after taking this into concern. The employee must be aware of the fact that, inflation ever time can flush the savings (Merton, 2014). However, most of the individuals do not recognize the possibility serious impacts of inflation. For example, if the inflation is at 3%, means $100 dollar at present will be valued at just $67.30 after 20 years. In this situation, a total of 1/3rd loss will be faced in value. At the age of 35, further, the amount would be declined to $34.44. Thus, it is significant to ask for retirement savings advice and measures that can assist in preventing inflation threat.
Diversification
Usually, people forget diversification which results in additional risk to their investments. Titman, Keown and Martin, (2017) asserted that in the opinion of many people that they are diversified since they have invested their money in mutual funds, but the reality is that they are investing in particular asset class: equities. If one has to get true diversification it can be done only with the help of self-directed IRA, it regulates investments in various assets, for example; real estate or private lending.
Tax
Present income level, tax bracket, and the types of tax-deferred retirement savings plans of an employee has a significant part in how much money employee can save for employees retirement (Brown, Cederburg and O’Doherty, 2017). By maximizing your pre-tax contributions to employer-sponsored plans and Individual Retirement Accounts (IRAs), the employee can take advantage of the deferred benefits of such plans .Contributions of superannuation funds can be classified into two categories in terms of taxes:
Tax-deductible: Tax of at least 15% will be reduced from the contributions made by employees as it takes entry in fund; these are also called concessional contributions.
Non-tax-deductible: on the contributed super the tax will not be deducted when it enters the fund, within the particular limits. It is also called non-concessional contributions.
Comparison of superannuation funds in Australia and India
Australian Superannuation means the arrangements placed by the Australian government to help individuals in Australia to amass money for retirement income. Superannuation funds within Australia are considered as partly mandatory and are motivated by tax benefits(Hutcheson and Newell, 2018). The government of Australia has set minimum standards on the contributions made by employees and the superannuation funds management. It is mandatory for the employers to contribute towards superannuation for their employees over the wages and salaries of employees,
Superannuation benefit is referred as a retirement benefit given to the employee and offered by the employer. In short, superannuation benefit means the pension plan carried out by the employer for their employees, wherein some amount is contributed by the employer to a superannuation group for the investment and retirement purpose (Edmonds, Holle and Hartanti, 2015). Further, employees began to receive a pension based on the plan type which the employer has selected at contribution stage, also the choice that employer might practice at retirement stage.
On the other hand, Superannuation funds in India are pre-set and fixed by company or employer, employees have no power to choose their own plan type and make decisions on the same (Goel and Mani, 2018). From scheme to benefits everything is set by the company, and guidelines are provided to employees to provide them a better understanding of the overall retirement plan.
Based on above investigation, it can be concluded that tertiary employees can make use of the combination of both defined benefit plan and investment choice plan in order to offset the retirement portfolio in an effective manner to ensure diversification. The mixture of these plans can help in securing their lifetime savings, while contribution in superannuation funds will make sure that their financial targets are met. Thus, the employee will be benefited with these investments by higher income and returns, by which employees can enjoy the benefits and turning the investment into worthwhile.
References
Brown, D.C., Cederburg, S. and O’Doherty, M.S., 2017. Tax uncertainty and retirement savings diversification. Journal of Financial Economics, 126(3), pp.689-712.
Cheah, K.K., Foster, F.D., Heaney, R., Higgins, T., Oliver, B., O’Neill, T. and Russell, R., 2015. Discussions on long-term financial choice. Australian Journal of Management, 40(3), pp.414-434.
Cummings, J.R., 2016. Effect of fund size on the performance of Australian superannuation funds. Accounting & Finance, 56(3), pp.695-725.
Donald, M.S. and Le Mire, S.M., 2016. Independence and the governance of superannuation funds.
Edmonds, M., Holle, C. and Hartanti, W., 2015. Alternative assets insights: Super funds-tax impediments to going global. Taxation in Australia, 49(7), p.413.
Froidevaux, A., Hirschi, A. and Wang, M., 2016. The role of mattering as an overlooked key challenge in retirement planning and adjustment. Journal of Vocational Behavior, 94.Pp.57-69.
Gerrans, P., Strydom, M., Moulang, C. and Feng, J., 2016. Investment strategy on retirement savings: An analysis of the experience of fund members. JASSA, (2), p.54.
Goel, S. and Mani, M., 2018. Prediction of Future Performance of Mutual Funds on the Basis of Past Performance. IJAME.
Grable, J.E. and Carr, N.A., 2014. Risk Tolerance and Goal-Based Financial Planning. Journal of Financial Service Professionals, 68(1).
Hutcheson, T. and Newell, G., 2018. Decision-making in the management of property investment by Australian superannuation funds. Australian Journal of Management, p.0312896218754476.
Kireeva, E.V., 2016. Effective management of personal finance. ??????????? ????????? ???????? ????? ? ??????????, (5-7), pp.5-7.
Merton, R.C., 2014. The crisis in retirement planning. Harvard Business Review, 92(7/8), pp.43-50.
Muratore, A.M. and Earl, J.K., 2015. Improving retirement outcomes: the role of resources, pre-retirement planning and transition characteristics. Ageing & Society, 35(10).Pp.2100-2140.
Peng, X., 2017. Information cost and member choice in the Australian superannuation industry.
Thorp, S., Bateman, H., Dobrescu, L., Newell, B. and Ortmann, A., 2017. Flicking the Switch: Simplifying Disclosures to Improve Retirement Plan Choices.
Titman, S., Keown, A.J. and Martin, J.D., 2017. Financial management: Principles and applications. Pearson.
Xingyun, P.E.N.G., 2015. Time Value of Money. World Scientific Book Chapters. Pp.49-70
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