Fin200 Corporate Finance - Free Assessment Answers

Answer:

Introduction

Many companies provide extra benefits to their employees such as insurance, pension, medical, fitness membership, stock option benefit etc., here in this study we are going to look in detail the pension benefits to the employees. There are three sectors in the economy on which the market works. The most important is the tertiary sector. This sector acts as veins work in a human body. The service industry is very important for the moving of work. Here we are analysing the best pension plans for the tertiary sector. The choice of plan is solely for the employees. The employer does not interfere in the selection matter. The employer has to contribute to the pension fund of the employees.

Working of pension

There are three major parts of a pension the employer, employees and the pension trust. The pension trust is the legal entity that keeps a hold on the pension investments and manages to disburse the fund when the employees retire.

1. The employees provide the employer services in lieu of which wages are the reward.
2. Contributions are made by the employer
3. The payment of the pension is done from the pension trust to the employees in the future.

There are two kinds of pension defined benefit plan and investment choice plan which is also known as defined contribution plan. 

Pension Age

The age of pension is the fundamental part of the Australian retirement system which gives a safety to those who are unable fully to manage themselves after retirement.

The chart above shows that the ration of the population with an average age of 65 will increase by 13% to more than 22% by the year 2050. The ration of the working supporters to the retired people will decrease from 5 per person to 2.7 per person by the end of 2050.

The Australian government is planning the rescheduling the retirement age. Current it is 65 years. The reason of rescheduling is the long period after retirement. The improved medical facilities and the working nature have made many people live longer and healthier.

Define benefit plan

A traditional retirement plan which is also called as final salary. Define benefit plan is an employee benefit plan. Thin define benefit plan the employer contributes a defined amount for his employees future on the basis of employees salary and the number of years of his services given to the company (Anon, 2007). The pension plan called define benefit plan is a plan under which the employer of the company commits the employees to pay a specific confirmation to every eligible employee when they will retire. The defined benefit plan is one of the biggest liabilities which is highlighted on the balance sheet. This liability catch’s the attention of all the stakeholders, management, analysts and the media (Anon, 2012).

Example- Calculating Hypothetically the average retirement age is 75 years can be 1% x average service years 30x average salary 4000= 1200 per month pension

Define benefit plans guarantee a minimum benefit to the plan holder. This plan provides assurance to the employees that he will get the financially secure even after his retirement. The liability of the employer increases as the employer has committed to employees to contribute to their fund, this means in any market conditions the confirmation will be continued. With the above details, some advantages can be listed

Advantages

1. Continue with the same standard of living after retirement- The pension plans are contributed so as to get the money to maintain the current status even after retirement. Whatever the plan it may be but the objective is same behind all the plans. The main aim of define benefit plan is the provide the maximum financial income to the employees so that they can maintain themselves as before retiring
2. The defined benefit plan is an icing in the cake benefit offer to the employees by the employer. The defined benefit plan not only provides financial security after retirement but also deferred pay increment to the employees (Basu & Drew, 2010). The employer is also a benefit as the benefits of define benefit plan attract competent employees in the company.
3. Other benefits
4. Tax rebates are received on ever contribution in the define benefit plan.
5. The employees get the confirmation from the employer but it is not part of the payroll taxes as such contributions are not calculated in the salary of the employees.
6. The income from the contribution in the define benefit plan is also tax-free.
7. The liabilities of the contribution have vested the employees as their membership starts.
8. If in case the employee dies than the entire amount is paid to the spouse. Further, in case of a nonliving spouse, the fund's benefits and the amount is paid to the heir.
9. The define benefit plan invested amount is the property of the employees. If Incise the company goes bankrupt than also the amount cannot be seized.

Unfunded benefit plan

The define benefit plan has two variants the funded benefit plan and the unfunded benefit plan. The funded benefit plans included the investment done in the assets (Gallagher & McKillop, 2010). The funded benefit plans have enough assets to pay the future liabilities of the pension. These funds itself hold enough money that the pension liabilities are secure (Stockton, 2017). Whereas the unfunded benefit plan is the one which did not include the investment in the assets. Generally, unfunded benefit plan is the result of organizations budget problems or sometimes the management decisions not to opt the contribution appropriate funds. The pension is insecure in unfunded benefit plan (Davis & Fraser, 2012).

Investment choice plan

To choose the investment plan is not a tough task, but it’s very important. The major difference between the plan's options is that the amount the employees need for retirement will differ which can change the lifestyle of the employees after retirement. The plan which the employees choose in investment choice plan is direct market linked as they are invested in different assets and the returns are linked with the market performance (Holzmann, Palmer & Robalino, 2012). The goal of investment choice plan is to let the employees plan and choose the best investment portfolio that can match their personal risk returns, which finally can increase their retirement income. To open an investment choice plan the employees have to go to the concerned company office to account, by how much amount the employee wants to open the account that depends on the employees desire only (Moulder, 2011). This amount is in the consideration of the amount the employee is planning to get at the time of retirement. The monthly payment done in the investment choice plan account is calculated by the advisors of the company of which the employee is planning to take the plan.

Investment choice plan has two contributions to the account of the plan that is the employer’s contribution and the employee’s contributions. The employee can make changes in the plan as and when he wants. He can also modify the investment process as per his comfort. This is a positive aspect attached to investment choice plan. The need to make changes in the plan may arise when the effect of market fluctuations is negative on the funds. The investment choice plans have some secured funds also which are not much affected by the market fluctuation. These make a list of government funds, trustee funds, some shareholders funds (Naegele & Means, 2011).

Advantages of pension plans 

To avail the same lifestyle even after retirement these pension plans are taken. This is the biggest benefit of planning the life after retirement. There are some other benefits also as under. 

Long term saving- The pension plans start from very early years of working. The payment of premium is done monthly and it is done for several years. This gives a practice of saving and the amount deposited is saved for a long time. The returns are on this long term savings. 

The negative effect of inflation- The pension plans are designed in such a way to be safe from the effect of inflation. The balance in two third corpus amounts is maintained to be safe from the inflation. The effect of inflation is nullified in the long term investments (Brown, 2004).  

Plan of choice- Any plan for pension opts whether it is defined benefit plan or investment choice plan in both the plans the government has made rules to prevent the pension funds. It is irrelevant that which company employees have invested or if the companies go insolvent the payment of pension will be paid (Moran, 2012). 

Facts help in Decision making 

Financial Goal- What are the financial needs of an employee at the time of retirement and even after that? This helps is deciding which pension plan to choose. Higher the requirements will have a higher risk. To fulfil higher need more money is needed so the employees opt investment choice plans (Egelberg, 2010). 

Risk- Low-risk low returns. The investment done in define benefit plans are not linked with the market; it’s safe from the market fluctuations. The amount invested has no effect on the market movement and the amount is safe. On the other side, the investment in investment choice plan is a direct investment in market plans. The investment is directly affected by the fluctuation on the market. The amount of investment gets affected by positive or negative movements. 

Inflation- The market conditions in which everything gets expensive more than the exception and the income remains low is inflation. Investment choice is affected by the inflation. The direct link with the market has an effect on the investment made by the employees (Ezra, 2015). Whereas the define benefit plan has no effect on the amount committed at the maturity. The define benefit plan is long time investment and the effect of inflation is nullified. Therefore the define benefit plan is beneficial. 

A number of years of investment- The time for how many years investment is made is a very important fact to final the fund. There are long term funds and short-term investment plan. The employees willing to invest for the long term can opt the define benefit plan, whereas for short time the investment choice plan is beneficial. 

The time value for Money 

The money loses its value with the passing time. It is required to consider the time value of money in any in any investment. The value of money is different at different time lapse. Money can be put to productive use, therefore, the value depends on  when the money is paid or received, the market analyses results that the value of money which was higher yesterday is higher today. But the assets are more valuable today than it will be tomorrow. The study of the time value of money helps the employee in making a correct choice regarding which plan of investment to choose. The analysis of time value for money also helps the employee to know the amount which they will get at the time of retirement (Kelly, 2012). Different plan has different policies regarding the time value of money. Define benefit plan and the investment choice plans also have their own effects on the money value they have there on measures and process to overcome devalue money. The inflation is one of the market conditions which affect the investments in the market. To calculate the net value of the investment time values places an important role. The difference in the value of money in yesterday and today is known as time value for money (Maurer, Mitchell & Rogalla, 2009). Thus the define market plan is more beneficiary to choose to cover come to the effects of time value of money.

The pension is free of tax up to the extent of one third only. The remaining two-third is taxable. The investment choice plan is market linked and has no tax benefit tax slab of income tax. Whereas the define benefit plan is tax benefited at the time of payment of the premium as well as at the time of maturity when a lump sum amount is received. Here also it’s analysed that the define benefit plan has more tax savings as compared to investment choice plan.

References

Anon, 2007. Financing the Future III, report 3: Managing Unfunded Liabilities: Will Your Hospital be Prepared? Excerpt.(hfma's financing the future)(Excerpt). Healthcare Financial Management, 61(11), pp.48–49.

Anon, 2012. Defined-benefit plan inside a 401(k). Best's Review, 113(1), p.51.

Basu & Drew, 2010. The appropriateness of default investment options in defined contribution plans: Australian evidence. Pacific-Basin Finance Journal, 18(3), pp.290–305.

Brown, Kerry et al., 2004. Employees' Choice of Superannuation Plan: Effects of Risk Transfer Costs. The Journal of Industrial Relations, 46(1), pp.1–20.

Davis, K. & Fraser, S., 2012. Insuring defined-benefit plan value: An examination of the survivor benefit plan (SBP) decision. Financial Services Review, 21(4), pp.275–290.

Egelberg, J., 2010. Multiemployer Plan Issues: The Variable Defined Benefit Plan. Journal of Pension Benefits, 17(4), pp.46–47.

Ezra, D., 2015. Defined-Benefit and Defined-Contribution Plans of the Future. Financial Analysts Journal, 71(1), pp.56–60.

Gallagher, R. & McKillop, D., 2010. Unfunded Pension Liabilities and the Corporate CDS Market. The Journal of Fixed Income, 19(3), pp.30–46,3.

Holzmann, R., Palmer, E. & Robalino, D., 2012. Nonfinancial Defined Contribution Pension Schemes in a Changing Pension World Gender, Politics, and Financial Stability, Washington: World Bank Publications.

Kelly, A., 2012. The Preservation of the Insured Defined Benefit Pension Program. Academy of Accounting and Financial Studies Journal, 16(2), pp.97–124.

Maurer, Mitchell & Rogalla, 2009. Managing contribution and capital market risk in a funded public defined benefit plan: Impact of CVaR cost constraints. Insurance Mathematics and Economics, 45(1), pp.25–34.

Moran, A., 2012. Electronic Disclosures of Participant Benefit Statements. Employee Relations Law Journal, 37(4), pp.71–81.

Moulder, Ryan P., 2011. Controlled group liability: the private equity fund's side of the story. Journal of Deferred Compensation, 16(4), pp.19–47.

Naegele, Richard A. & Means, Kelly A., 2011. Multiemployer pension plan withdrawal liability. The Journal of Pension Planning & Compliance, 37(1), pp.45–71.

Stockton, K.A., 2017. Survey of defined benefit plan sponsors. Pension Benefits, 26(1), pp.7–8.