Defined Benefit Plan: Factors and Decision-Making Process

This article discusses the factors considered by tertiary sector employees in deciding whether to place their superannuation contributions in the Defined Benefit Plan or the Investment Choice Plan. It also explores the importance of the concept of time value of money and taxes in this decision-making process.

Defined benefit plan
Module Number-
[DATE]
Hewlett-Packard
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Table of Contents
Introduction...........................................................................................................................................1
Description of the different plans..........................................................................................................2
Investment choice plan......................................................................................................................2
Defined benefit plan..........................................................................................................................2
Factors considered by tertiary sector employees in deciding whether to place their superannuation
contributions in the Defined Benefit Plan or the Investment Choice Plan.............................................3
Issues relating to the concept of the time value of money, taxes etc., might be important in this
decision-making process........................................................................................................................4
Conclusion.............................................................................................................................................5
References.............................................................................................................................................7

Introduction
The need of people now for fulfilling their service requirements is now being satiated
successfully by the emerging tertiary sector of economy. The gap between the requirement of
service and its efficient fulfilments is reduced to a negligible sphere now. The tertiary sector
of economy has phased out the tension which earlier existed in the economy in relation to the
consumer demand of high quality and appropriate services. This sector of economy is
indulged in the provision of every possible service to fulfil the customer requirements. The
development of any economy in the current era is determined when its focus shifts from the
primary and secondary sector towards the tertiary sector (Yow, 2016). The different kind of
service organisation and businesses that formulate the tertiary sector include schools,
financial institutions, restaurants, transportation business, salon services, and etc. The list is
almost unending.
Like any other sector of economy, the tertiary sector also employs employees in several fields
to get the business running. These employees are termed as tertiary sector employees. The
employees of this sector also get several benefits in addition to the basic salary attached to
their jobs. These benefits could be in cash or in kind. One such benefit in cash superannuation
contribution, which although is not paid to employees immediately but certainly towards the
future help of employees. The traits of this fund are similar to pension fund. Both employee
and employer make monthly contribution to this fund where money gets accumulated. The
sense of future financial security is created in the employees’ mind due to creation of this
fund. The choice of placing the contributions of superannuation can be varied depending
from one country to another. Likewise, the Australian superannuation funds popularly
provide two major choices being, investment choice plan and defined benefit plan
(Cummings, 2016).

Description of the different plans
There are several investment options which could be used by the tertiary based employees to
strengthen the overall return on capital employed on their investment.
Investment choice plan
The investment choice plan, as the name suggests allow the employee to invest the amount
accumulated in the fund in an investment portfolio. The contribution of the employer in this
type of fund is limited to a percentage of the salary of the employee. Other than this definite
percentage there is no other contribution obligation on the employer. The kind of investment
choice made by the employee enables him to earn interest likewise upon the investment.
Several investment options could be there ranging from investment in shares, property or a
portfolio comprising of both. Research have shown that the large proportion around 80% of
Australian population having superannuation accounts chooses to invest the funds in either
‘growth’ or ‘balanced’ investments wherein the investment of around 80% of their funds goes
in growth assets being property and shares (Anderson, Clark, Ramsay, and Shekhar, 2016).
Defined benefit plan
The defined benefit plans are termed defined for the reason of prior knowledge available to
employer and employee in relation to the manner in which retirement benefit attributable to
the employee shall be calculated. The plan is completely sponsored by the employer and
hence the responsibility of investment decision making, investment management and
investment risk is borne by the employer. An actuary periodically reviews the contribution
rate at which contribution is required to be made by the employer. If the rate is less than
desired, the same has to be met by the employer. The payment from this fund shall be made
to the employee in several forms be it in lump sum or pension or a combination of both. For
computation of benefit under the defined benefit plan is computed by taking into
consideration several factors including employee’s age at retirement, pay of employee, years
of employee’s service and salary at the age of retirement (Shields, and North-Samardzic,
2015).

Factors considered by tertiary sector employees in deciding whether to place their
superannuation contributions in the Defined Benefit Plan or the Investment Choice
Plan
The decisions made by the tertiary sector employees whether to invest their superannuation
funds in the Defined Benefit Plan or Investment Choice Plan is not an easy one. Because of
the high level of uncertainty attached to the financial result of both these plans, several
factors are considered by employees to make a rational decision. Also the pros and cons
attached to the different superannuation funds are different making the employees again
consider several factors. However, with the economic changes, these factors may get changed
accordingly. These factors are discussed as follows:
 Financial stability: the financial stability of the employee intending to make decision to invest
the superannuation fund largely impacts his choice. For employees whose financial status is
strong is less likely to averse risk and generally opt for the investment choice plan. However
for the employees whose earnings are limited to run their daily living are more risk averse
and are more likely to choose the defined benefit plan (Hutcheson, and Newell, 2018). There
is need to assess the financial stability and it is used by the investors to lower down the risk
invested with the investment plan.
 Age of employee: the employees with young age are found to be investing their funds more
in the investment choice plan. The period lying between the tenure of investment and
retirement of these employees is large. As a result these employees are in a position to
effectively use the market movements to gain benefit from them. Also the time available to
make changes in the portfolio by gaining benefit from market changes is explicitly high. The
stagnancy of portfolio can be avoided by them. However, for the employees who are older in
age their future living depends highly upon the retirement benefits. They are less expected to
invest in investment choice plan because of less tie availability to churn portfolios and
assume risk (Tan, and Cam, 2015).
 Employee mobility: the employees who are likely to switch jobs are often seen investing in
the investment choice plan as in this investment option an accumulation of collection of funds
from all employees is kept together and invested as per employee’s will. The investment
choice plan is preferred as the defined benefit plan works by opening of different defined
benefit plans for every different employer the employee works under. This as a result
segregates the overall benefit available to the employee.

 Historical performance of the plans: the foundation lying upon which most of the employees
invest their superannuation funds rest on the observation of performance depicted by both the
plans in the past. The performance shown by these plans in the recent past, say a year, six
months, or a quarter is compared. This shows the changes in the return available to the
investors on the basis of the invested capital. Further, it is also observed that around 60% to
80% of Australian employees choose the investment choice plan as their default
superannuation fund investment option.
 Level of information available with the employees: the information which the different
employees have about the current market performance and expected market performance
effects their investment decisions. The employees who are very well aware of the manner of
market movement opt for the investment choice plan usually. This is because of the extensive
information available to them which can be applied to gain high interest income. Generally,
the lesser informed employees usually choose the defined benefit plan (Earl, Gerrans, Asher,
and Woodside, 2015).
 Gender: the gender of the employees affects their decision of investment of superannuation
funds. It is observed from research that the women are more risk averse than men
comparatively. They do choose the high risky investment plans if the return observed upon
them is higher. It is found that women are tend to take less risk as compared to men due to
their investment and saving habits. However, the results may vary with the different factors
affecting women in their official and personal life.
 Sense of being secure: the employees who want to stay in a secured position with lesser risk
usually opt the defined benefit plan because the insecurities attached to it are very less in
comparison to the investment choice plan. The investment choice plan is on the other hand is
dependent more upon the market movements and the sense of security is doubtful.
In spite of all these factors the main determinant of the choice of investment plan somehow is
construed by the personal interest of the employees largely.
Issues relating to the concept of the time value of money, taxes etc., might be important
in this decision-making process
The time value of money as well as the taxes prevalent in the economy also is an important
factor which impacts the choice of investment of superannuation contribution either in the
investment choice plan or in the defined benefit plan. The effect of both of these factors is
stated as follows:

 Taxes: taxation calls the employees to make a compulsory payment to the government on the
income earned by them, be it the benefit on retirement. There are certain exceptions however,
where no taxes are paid by the employees on the retirement benefit paid to them. These
situations include, incapacity of the employee to perform, death of the employee, etc. In
situations other than these the tax is deducted on the retirement benefit. When the employee
chooses the defined benefit plan, the tax to be paid by the employee is limited to the benefit
which is again limited to the employer’s contribution accumulated over the working life of
employee. There are no additional elements which shall be taxed in this alternative
(Williams, 2018).
However, if the employee chooses the investment choice plan, the amount contributed to the
investment choice plan is investment by the employee in a portfolio of investments. The
amount invested by the employee in the portfolio of investments also adds to the fund in form
of interest income. Hence, the tax is bound to be paid on the contribution amount and also on
the interest income earned upon it. Owing to this fact, many employees choose the defined
benefit plan.
 Time value of money: time value of money raises the importance of investing the idle
standing money to increase its worth in future. This is based upon the concept that value of a
rupee today is more than it would be in future, because the inflation of future shall drop down
its value. Hence, investment of today’s money shall compensate the fall by adding to the
money volume in future. Comparing the two above discussed alternatives on the basis of the
concept of time value of money, the investment choice plan turns out to be better as it leads
to increasing the contribution of superannuation funds by generating investment income.
While, the defined benefit plan on the other hand leads to stagnancy of the accumulated
balance of the superannuation funds and add nothing more to it (Murphy, 2018).
Conclusion
As discussed, the development of economy of a nation is judged nowadays by the efficient
shift of economy from the primary and secondary sector to the tertiary sector. In order to
motivate employees to shift their paradigm towards tertiary sector, it is important to provide
them such benefits as discussed above. This shall incentivise them to incline towards the
service or tertiary sector rather than work in the primary or secondary sector. Now in the end,
it could be inferred that investor needs to choose only those investment option which gives
them higher return considering the impact of the time value of money

References
Anderson, M. E., Clark, M., Ramsay, I., and Shekhar, C. (2016). Super behaviour: a note on
young Australian adults’ engagement with their superannuation accounts. Australasian
Accounting, Business and Finance Journal, 10(4), 58-69.
Cummings, J. R. (2016). Effect of fund size on the performance of Australian superannuation
funds. Accounting and Finance, 56(3), 695-725.
Earl, J. K., Gerrans, P., Asher, A., and Woodside, J. (2015). Financial literacy, financial
judgement, and retirement self-efficacy of older trustees of self-managed superannuation
funds. Australian Journal of Management, 40(3), 435-458.
Hutcheson, T., and Newell, G. (2018). Decision-making in the management of property
investment by Australian superannuation funds. Australian Journal of Management, 43(3),
404-420.
Murphy, P. (2018). Prosperity postponed: The cycle of low-growth big-statism, and how to
break it. Quadrant, 62(5), 10.
Shields, J., and North-Samardzic, A. (2015). 10 Employee benefits. Managing Employee
Performance and Reward: Concepts, Practices, Strategies, 218.
Tan, M. G., and Cam, M. A. (2015). Does governance structure influence pension fund fees
and costs? An examination of Australian not-for-profit superannuation funds. Australian
Journal of Management, 40(1), 114-134.
Williams, R. (2018). Managing superannuation fund investment taxes. Taxation in
Australia, 53(2), 77.
Yow, M. C. (2016). Employee interpretations of organizational citizenship behavior in
tertiary sector organizations: A generic qualitative study (Doctoral dissertation, Capella
University).