Corporate Financial Management: Defined Benefit vs Investment Choice Pension Plans

Corporate Financial Management 1
CORPORATE FINANCIAL MANAGEMENT
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Corporate Financial Management 2
CORPORATE FINANCIAL MANAGEMENT
Under the superannuation policy, employees are encouraged to invest and save for the
future and specifically their year of retirement by making minimum contributions to
superannuation investments hence complying with the superannuation or retirement funds
requirements. Employers are also mandated to make contributions to these superannuation
investments on behalf of their employees. These allocations made are derived from a percentage
of their income. This superannuation policy initiative helps in reducing the burden associated
with the social security system by providing payments for a pension to care for individuals
during their stage of the retirement of their lives. On the other hand, it also helps employees to
successfully invest the amount that they contribute to providing enough income for funding those
that are close to the employees such as their relatives and friends.
As a result, employees currently have a higher option in deciding on the types of assets as
well as funds that they are contributing to the superannuation should be invested in the scheme.
On this basis, the employees remain with two forms of schemes that they have to make a
selection of, which include an investment choice plan and DB plan.
Defined Benefit versus Investment Choice Pension Plans
An employer’s pension program can be variedly classified into two broad types which
can be an investment choice pension plan (IC) and DB pension plan. The investment choice
pension plan restricts each and every employee creates an account where both the employee and
the employer make continuous contributions. The accruing benefits are dependent upon the
contributed funds as well as investment earnings that are accumulated in the statement. Most of
the time an employee has to make a different choice concerning the type of assets where the

Corporate Financial Management 3
collected funds will be invested in. The employees always have to determine every time the
value of the amount spent in the superannuation funds. Investment choice pension is a savings
account in trust with the tax-deferred for all the employees who are fully funded (Chaudhry,
Yong and Veld 2017).
In DB plan, the pension benefit that the employees are entitled to can be calculated using
a formula which considers the employee’s year of service, as well as salary or wages.
DB and IC plans possess different characteristics concerning the risks that the employees
and employers, the funding flexibility, the sensitivity of importance to inflation, and the
significance of supervision by the government (Kriz and Chen 2017).
Investment choice pension plan
Under this scheme, the employer, as well as the employee, makes continuous
contributions to the pension retirement account of the employees. The total amounts of money
contributed by the employees are always put as a predetermined fraction of the salary of the
employees through the value provided is not constant over the period (Charlton and McKinnon
2018).
Contributions from both the employer and employee are not tax-free, while investment
income accrues are not tax-deductible. Employees have to choose their own as to how the
investment will take place in their accounts. The principle allows the amount of money
contributed for investment to be invested in security, even though in practice most schemes
restrict investment options to be in the form of stock, bond, as well as the funds of the money-
market. The employees who have retired from work will either obtain annuity or lump sum, the
size of each is based on the number of funds that are in the retirement account. Employees will,
therefore, endure all risks that are associated with the investment; the consideration for

Corporate Financial Management 4
retirement is by description fully funded; therefore, the Company has no responsibility but only
to make a periodic contribution (Bithas, Latinopoulos, Kolimenakis and Richardson 2018).
IC plan Valuation involves measuring the assets market value held in the account for the
retirement of the employees. Nevertheless, as an advisor for individual financial planning, the
sponsor of IC plan sponsor often offers employees with the specified size of a life pension
beginning at the age of retirement that can be bought now with the funds that are in their account
under different circumstances. The exact size of the annuity for retirement will entirely be based
on the realized retirement’ interest rates, the performance of investment of the retirement funds,
and employees’ wage path (Landon and Smith 2018).
DB versus Investment choice annuity plan
DB Plan
DB scheme emphases on the benefits’ flow that a person will obtain upon retirement,
while IC scheme emphases on the assets value currently invest at retirement account. A classic
Defined Based plan should find out the benefits of the employees as a function of the total years
of wage history and service (Paradi, Sherman and Tam 2018).
The current value of accrued liabilities might increase as the service continued because of
the factors stated below:
• When the year of service increase, DB will also increase
• When the wage increases, the retirement benefit will also increase
• As time elapses, the time remain less until the retirement benefits start, hence, their
PV increases at the IR
Investment Choice and Performance