Retirement Investment Planning

Discuss about the FIN200 Corporate Financial Management.

In order to stimulate the habit of saving, the Australian government has acted as a support system, minimum efforts, charges and contribution fees are obliged on super plans so that employees can have the benefit of savings in their future retirement period (Prast and van Soest, 2016). Since the importance of savings is increasing amongst the employees, it is essential for the firms to provide them necessary superannuation plans while providing them with the appropriate knowledge of the same, to make it simple for the employees in choosing the best plan. The present study is based on the analysis and evaluation of the most suitable superannuation plan for tertiary sector employees to make investments and savings at retirement age. It is focused on Factors to be considered to determine to place their superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan. Further, it includes Issues related to decision making procedure.

In order to eliminate the forces pushed by social security system regarding pension plans, the introduction of low contribution level was made, supported by firms and government to promote higher savings for retirement stage. In Australia, there is the presence of viable and fair retirement laws that help employees in choosing their respective superannuation plans based on their need, expectations and wants (Clark, Lusardi and Mitchell, 2015). In the present era, it is significant for the employees to get aware and realize about the retirement planning and selection of superannuation plan to determine their retirement objectives as a whole. Considering the case of tertiary employees, their employment life is short, so they must do proper planning for their retirement to save their earnings in a viable manner. The organizations wherein tertiary employees are working offer them two type of retirement plan in order to safeguard their future and help them in managing their financial targets. These pension plans are Defined Benefit and Investment Choice plan.

Defined benefit plan

Defined benefit plan is a retirement plan financed and funded by the employer; it is highly beneficial for employees, as the amount is measured by using a specific formula. The formula considers various forces by which the overall working period of employee and their provided wages are taken into account. Since, this retirement plan is borne by employer or organization, the risk and management of the portfolio is also undertaken by them.  In other words, defined benefit plan is referred to a plan wherein employee is given compensation in terms of financial terms benefit, and the same is determined by using formula which reviews the concerns such as the last salary of employee and their employment starting date, along with considering their overall time they rendered their services to organization (Ali and Frank, 2018). Furthermore, some limitation are there when it comes to withdrawing finds; every organization has different methods to withdraw funds which employees are required to follow and comply with. Under this plan, the employee is given guarantee for a specified amount of pension funds, either on the lump-sum amount or by the withdrawal of funds.

Defined Benefit Plan or the Investment Choice Plan

Investment choice plan

Investment choice plan is a type of benefit offered by superannuation funds. This offer provides the eligibility to the investor for selecting if or if not they wants to make investment in retirement plan. Sorts of portfolio investments are placed in front of employees, wherein employees can make own decision and choose a plan (Aren and Aydemir, 2015). Employees agreeing to choose investment benefit plan are given the opportunity to retain own investment account inclusive of own efforts and funds sponsored by employers as well. Along with this, an annual assessment of earnings made in investment is measured wherein administration charges are deducted.

Further, it can be said that tertiary employees in the current context can do voting on asset types and type of portfolio according to the choice of investment to be made in superannuation plan while considering the strategies to make the investment.

Risk and uncertainty

Defined benefit plan and investment choice plan have risk exposures; it can be said that it is vital to consider these risks while selecting any of plan to ensure security and safety.  According to the employee perception, they are not likely to bear much risk because of low risk-bearing capacity and fear of losing earnings; in this case, employee should go for defined benefit plan (Prast and van Soest, 2016). It is because defined benefit plan has no or less risk associated due to the sponsorship of an employer. However, the employee can choose investment choice plan, if they have high risk-bearing capacity. There is the presence of no or less risk in the defined benefit plan, as it is entirely abided by the organization whereas there is the presence of high risk in investment choice plan because employee manages their own portfolio. Before making an investment, employees must consider and ask themselves if they are able to tolerate risk or not and must make a decision after that.

Thus, if the tertiary sector employee is not willing to get engaged with risk and are not risk-takers, then the most appropriate plan for them is the defined benefit one (Clark, Lusardi and Mitchell, 2015). Conversely, if the tertiary employees are risk-takers and are willing to get engaged with risk, then they must give preference to investment choice plan.

Financial status

Financial status is the key to know where an employee is standing currently and what their financial position is. It is significant to be determined to get in pursuit of income and savings while considering expenses and debts alongside. For developing an effective structure for savings, expenses and other related factors, it is essential to balance everything in an appropriate manner to ensure smooth base for decision making (Keele and Alpert, 2015). If the employee has weak financial status, that means if the employees do not have any investment,  savings and shares in financial terms for the future then must choose defined benefit plan , as it does not an associated risk. On the other hand, if the employee has saved some investment, savings and amount saved for future, then the employee must select investment choice plan, as they have the capacity and status to hold risk.

Factors to be considered to determine to place their superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan

Risk Factor of Inflation

There is a risk of inflation damage for the saved money for future. This risk can lower the value which is saved for the future by the employee. This is main rationale to be considered in order to ensure that their savings in the retirement plan are free of inflation damage, to do so appropriate methods and ways must be kept in mind (Topa, Lunceford and Boyatzis, 2017).

In addition to the above-described factors, following issues are required to be made viable decisions for retirement planning:

Time value of money

The time value of money is the notion that a general person is required to understand while doing personal investment and finance. There are three key rationales in order to support the time value of money. Initially, money can be invested to earn interest over the time, providing the possibility to get more of earning power. Moreover, money can be referred to inflation that means taking the consuming power away from the money over the time, which can lessen the value of same in the near future (Chandra, 2017). Lastly, mostly there is a risk of not obtaining the money in upcoming future if the person retains the money at the present time, and then there will be no uncertainty. In order to get a perfect prediction of the risk, it is very complex to do so, and thus it is difficult to make use of the same in an accurate manner.

In the TVM, the value of money gets declined as the time passes. The phenomenon is generally called inflation. This concept that cash in hand is highly worth rather than on a later date, it is because it can get returns are known as the time value of money (Aren and Aydemir, 2015). This theory has a higher value when it comes to thinking about investment or making investment. When a person makes an investment, then they are fundamentally consuming it today. At present, investors know that their money will be of less value because of inflation over time (Ball, 2017). Thus, the expectation of investor must depend on the terms that investment must grow at a higher speed when the value of money is declining. The TVM theory is probably one of the foremost theory in terms of financial planning or investment. If the employee does not want to appreciate the inflation damage that can impose on the spending power of the assets, it will be hard to do financial planning. It is essential for the employees to take into account that the present money is highly worthwhile that the similar amount at a later date (Keynes, 2016). If the money is investment immediately, it will be easy to earn a high return while ending up with a greater amount.

Issues related time value of money and taxes in decision making procedure

Hence, by considering the overall aspects of TYM theory, it can be suggested to tertiary sector employees to invest their money immediately, so as they can earn high ret5urn otherwise they will experience low worth and inflation damage on a later date (Earl, Bednall and Muratore, 2015). Further, it can be said that the money must be invested as soon as possible to earn interest rates and thereby higher returns.

Taxes

On the other hand, the decisions of retirement planning and pension plan are also affected by taxes either in positive or negative (Muratore and Earl, 2015). Tertiary employees are required to interpret about the applicable taxes on plans initially, and further, make decisions on selecting the same.

The pre-tax contribution might assist in increasing the savings  in the employee’s pre-years of retirement, whereas the after-tax contribution might assist in reducing the stress of tax at the stage of retirement (Mihaylov and et al., 2015). The retirement income or savings of employee can come up in the form of a retirement plan or wither the investment account of after-tax.

In pre-tax investments which are also known as tax-deferred, this will enable the employee to delay their payment of the tax on the contributed amount and the generated earnings as long as they are in the account. The value of account might grow at a higher pace as compared to the taxable investment, as the gaining in the same account can develop tax-deferred (Williams, 2015). If the taxes are paid at the postponed date, there is a possibility for the investment or gaining of the employee to be taxed at a reduced rate.

The after-tax contributions can establish a free of tax income source in the near future, in case there is the satisfaction of some qualifications and requirements.  In the saving years of employees, the contributions made will not be deductible by tax, but the free of tax withdrawals can help in reducing the net taxable income when the employee is at the stage of retirement (Dalton, Dalton and Cangelosi, 2016). There is one more option that can be considered by the employee which is an annuity; it is a lasting insurance type that helps in paying out income. Generally, most of the investors buy an annuity in order to offer an integration of security, tax-deferred and retirement income.

Conclusion

By considering the present study, it can be concluded that tertiary employees must make investment choices for their retirement planning by considering all the factors associated with the plan to ensure safe and wealthy pension plan.  As a concluding statement, it can be said that tertiary employees are required to select a plan in accordance with their requirements along with considering tax obligations and the time value of money.

References

Ali, S.B. and Frank, H.A., 2018. Retirement Planning Decisions: Choices Between Defined Benefit and Defined Contribution Plans. The American Review of Public Administration, p.0275074018765809.

Aren, S. and Aydemir, S.D., 2015. The factors influencing given investment choices of individuals. Procedia-Social and Behavioral Sciences, 210, pp.126-135.

Ball, R.J., 2017. Inflation and the Theory of Money. Routledge.

Chandra, P., 2017. Investment analysis and portfolio management. McGraw-Hill Education.

Clark, R.L., Lusardi, A. and Mitchell, O.S., 2015. Employee financial literacy and retirement behavior: A case study.

Dalton, J.F., Dalton, M.A. and Cangelosi, R.R., 2016. Retirement planning and employee benefits. Money Education (Me).

Earl, J.K., Bednall, T.C. and Muratore, A.M., 2015. A matter of time: Why some people plan for retirement and others do not. Work, Aging and Retirement, 1(2), pp.181-189.

Keele, S. and Alpert, P.T., 2015. Preparing for retirement in uncertain times. AJN The American Journal of Nursing, 115(1), pp.50-55.

Keynes, J.M., 2016. General theory of employment, interest and money. Atlantic Publishers & Dist.

Mihaylov, G., Tretola, J., Yawson, A. and Zurbruegg, R., 2015. Tax compliance behaviour in Australian self-managed superannuation funds.

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.

Prast, H.M. and van Soest, A., 2016. Financial Literacy and Preparation for Retirement. Intereconomics, 51(3), pp.113-118.

Topa, G., Lunceford, G. and Boyatzis, R.E.D., 2017. Financial planning for retirement: A psychosocial perspective. Frontiers in Psychology, 8, p.2338.

Williams, R., 2015. After-tax investing for superannuation funds: What should managers manage?. Taxation in Australia, 50(3), p.137.