Superannuation Plan Decisions for Tertiary Sector Employees: A Report

This report delves into the critical factors tertiary sector employees should consider when choosing between a Defined Benefit Plan and an Investment Choice Plan for their superannuation contributions. It provides a detailed analysis of both plan types, highlighting their respective advantages and disadvantages, such as the allocation of investment risks, flexibility in investment choices, and the impact of inflation. The report emphasizes the importance of understanding the time value of money, tax implications, and the individual employee's risk appetite and long-term financial goals. It further explores the complexities of funding, particularly the underfunding issues in defined benefit plans and the fully funded nature of investment choice plans. Ultimately, the report aims to equip employees with the necessary information to make informed decisions that will maximize their retirement benefits and align with their personal circumstances, acknowledging that the optimal choice depends on a variety of factors including risk tolerance and tax consequences. The report concludes that while both plans have pros and cons, the ultimate aim should be to provide maximum benefits to the retirees and their spouses throughout their retirement era.

Question:
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. (2000 words)
INTRODUCTION
The tertiary sector has nowadays become the biggest constituent of a country’s economy.
Such as in a developed economy like that of UK, it comprises of almost 80 percent of the
GDP and an equally same ratio of employment as well. In the past century, there has been a
shift from a manufacturing based economy to a service sector economy. Tersiarisation
comprises of the service sector contributing to comprise of the largest chunk of the economy.
The employees belonging to this sector receive various benefits and contributions from their
employers such as in the form of provident fund and superannuation contributions.
Superannuation is an organizational pension plan which is formed by a corporate for the
advantage of its staff members, a sort of a retirement benefit plan and the funds are decided to
be invested in some of the plans available such as the defined benefit plan and the investment
choice plan. The concentration on superannuation and persuading people to save and invest
for their future, specifically their retirement years has been impressed upon in the last 20
years in Australia too. One of the biggest development in the superannuation funds
management and service provisions in the present day has been a major increase in the kind
of superannuation fund products and investments and retirement plan options, wherein the
members presently have lot more suppleness in choosing between the kind of funds and
assets their superannuation contributions are put in. In line with the enhancing investments
choice, two forms of superannuation plans are being discussed i.e. a defined benefit plan and
investment choice plan (Tejvan, 2016). There are various factors which has to be considered
while deciding upon whether the superannuation funds should be put into a defined benefit
plan or the investment choice plan. The said essay details about each of the plans specifying
the various issues which should be taken into consideration such as time value of money,
taxes etc before deciding upon the same.

DEFINED BENEFIT PLAN
Various researches have been carried out in the past with regards the defined benefit plan and
it has been construed that the said plan is the one which gives benefit to its staff members at
the time of retirement and the benefit is computed basis a formula which takes into account
various factors such as the employees final average salary, age and the years of service in the
organisation. The retirement benefit is computed by the below mentioned formula:
Retirement benefit= Benefit salary * lump sum factor* average service fraction* length
of membership.
The defined benefit plan has been one of the most prevalent plans due to various factors.
Firstly, the particular plan entails to provide the employees with a greater retirement
advantage than what they would have received via the other available retirement schemes,
specifically if the employees are healthy enough to be able to live for a longer duration post
retirement. Secondly and one of the most crucial is that the defined benefit plan puts the
investment risks attached with the volatility in the markets upon the employer and not the
employee (us.axa.com, 2018). Thirdly, the since market fluctuation risk is on the employer,
therefore the investment related decisions are also a responsibility of the employer and not
the employee. Lastly, companies generally have a larger time perspective than the life
expectancy of the employee which makes it clear that the employers have a greater appetite
to take up the huge volatile conditions of the market over various market cycles (Adkins,
2010).
Further many employees want a monthly amount as their pension with the help of which they
expect to spend their life easily, for such employees the said plan is said to be the best as the
defined benefit plan enables monthly pension payment scheme (Erez, 2016). Thus these
factors are what makes the defined benefit plan lucrative for an employee.
INVESTMENT CHOICE PLAN
Another plan available to them is the investment choice plan which is basically a member
investment choice plan thereby it gives an option to a super fund member to have a power to
speak with regards where he would want his funds to be invested in. Being a part of the super
fund, the member has the option to select which asset class to invest in. There are various
factors that are required to be considered with this kind of superannuation fund investment
too This kind of a plan is a risky one as the employee is responsible for his decision and
hence the risk appetite of the investor plays a crucial role. Secondly the investment time
frame i.e. for what time frame will the super fund remain invested. Whether the employee is

nearing retirement or has just started with the investment. Lastly what does the employee
expect to gain financially in future.
Contributions from both the employee and the employer are tax deductible and the gains that
occur are free from taxes, thus the retirement account of an employee is totally financed by
definition but the firm has no ultimate accountability but for contributing an agreed sum
periodically. Thus the valuation of the investment choice plan is simple as it ensures
measurement of the market value of the assets which is held at the time of retirement. Here
the tangible size of the retirement annuity will be reliant upon the realised investment feat of
the retirement fund, the interest rate at retirement and the final wage path of the employee
(Murphy et.al. 2014).
FACTORS AND ISSUES TO BE CONSIDERED WHILE DECIDING BETWEEN
THE DEFINED BENEFIT PLAN AND THE INVESTMENT CHOICE PLAN
Since both the plans are well discussed, it is critical to make a decision as to which plan is
more suitable and beneficial for the tertiary sector employees, the defined benefit plan or the
investment choice plan. Various factors discussed above as well as issues such as tax related
and time values of money are to be taken into account before arriving at a conclusion.
Firstly, as is aid the investment choice plan is by nature a fully funded plan, which connotes
that the market value of the plan’s assets are equivalent to the responsibility of the sponsor to
the plan’s beneficiaries. However, in contradiction to the same, the defined benefit plans
funding means are complicated by nature. Here even if the plan’s assets are put into securities
which are listed wherein the market value is easy to determine, the problem is measuring the
responsibility level of the sponsor.
Further as is mentioned the investment choice plan is more risky as compared to the defined
benefit plan. The most sought after risk with regards the former plan is how the money in
traded securities perform, thereby making it an uncertain selection. But the same be curbed to
some extent such as the periodic payments of the investment choice plan may fundamentally
be utilised to buy deferred annuities which would enable generation of retirement income
streams which is equivalent to those offered by defined benefit plan also. The investment
choice plan as the name says provides ample flexibility to chose between a risk-return tactics
which is best suited to the employee’s personal choices and situations. Whereas in
contradiction to the same, the defined benefit plan compels people to accrue the part of he
pension of retirement saving in the form of deferred life annuities and thereby restricts the
risk return preferences.

For employees, the tax related issues with each of the above plan are fundamentally the same.
Employees are not required to pay taxes on the contributions made by the employers,
investment gains or the capital gains derived from these retirement plan assets until and
unless these benefits are received by them. But those employees who are a part of the defined
benefit plan have to pay taxes on their personal plan contributions in the year the said income
was earned. Mostly the private sector defined benefit plans do not ask for the contributions
from the staff members but the public sectors do. Thus under both the plans the gains are
subject to tax when the income is received by the employee. The outcome of the tax is reliant
on the form of benefit payment and not on the kind of plan chosen (ebri.org, 2005).
Nowadays inflation is a major issue across the globe. Thus when it comes to inflation, the
defined benefit plan is flawed. Under the said plan the benefits will be available to the
employees who terminate their employment much before their retirement are not indexed for
inflation which is happening between the date of termination and the retirement date. Thereby
those employees who start and end their career with one employer only are most benefitted
than those who keep on switching jobs. Another issue to be considered is that inflation post
retirement can wash away the value of the accumulated pension benefits. Especially this is
an issue for the investment choice plan whereas the defined benefit plan in the public sector
give routine increment in the benefits paid to the retirees.
Lastly, another major issue or factor to be considered is that the investment choice plan is
fully funded whereas the defined benefit plan is underfunded. Under the latter plan, although
the employees have the right to future gains as they work, however the employer does not
always totally fund the accumulating pension burdens. On the other hand, the former plan is
never underfunded as here the employer also has to be an obligatory contribution which is
known and can be part of the budget of the company (Forman, 1999).
CONCLUSION
Thus although both the plans have advantages and disadvantages attached to it, it becomes
difficult to be dependent on any one kind of the plan. The defined benefit plan is basically for
those kind of employees who do not want to take much risk whereas the investment choice
plan is basically for those kind of employees who want to take a risk and expect greater
returns. The defined benefit plan is an age old plan which is not beneficial for those
employees who keep on rotating from one job to another and is also not fully funded by the
employer. Thus whatever be the plan adopted for the investment of the superannuation funds,
the ultimate aim should be to provide maximum benefits to the retirees and their spouses
throughout the span of their retirement era.

Although, the defined benefit plan is a more conservative kind of a plan which mainly
ensures that the employees are getting a fixed amount during their retirement years even if
the same is not funded fully but has security and the entire burden is on the sponsor since the
maintenance of the fund is their issue, yet the investment choice plan being new is more
attractive for the present day employees. Employees who believe in taking risks and
demanding for higher returns chose the said plan as they can easily switch over investment
plans and gain better at par with the inflation as well at times. Sticking to one plan is a
difficult ask as both the plans have their own pros and cons. It all depends upon the risk
appetite and the tax consequence as well.

REFERENCES:
Adkins,T., (2010), The Defined- Benefit Plan’s Many Problems, Available at
https://www.investopedia.com/articles/retirement/10/demise-defined-benefit-plan.asp
(Accessed on 21st May 2018)
ebri.org, (2005), Defined Benefit and Defined Contribution Plans: Understanding the
Differences, Available at
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May 2018)
Erez,M., (2016), Choosing between a Defined Benefit Pension Plan and Commuted
Value, Available at
https://www.odlumbrown.com/documents/Content-Docs/ClientFinancialPlanning/Tax/
ChoosingBetweenDefinedPensionPlansAndCommutedValue.pdf (Accessed on 21st may
2018)
Forman,J.B., (1999), Public Pensions : Choosing Between Defined Benefit and Defined
Contribution Plan, Available at http://jay.law.ou.edu/faculty/jforman/Opeds/msu-
publicpension.pdf (Accessed on 21st May 2018)
Tejvan, (2016), Tertiary –Service Sector of the economy, Available at
https://www.economicshelp.org/tertiary-service-sector/ (Accessed on 21st May 2018)
us.axa.com., (2018), Understanding defined benefit plans, Available at
https://us.axa.com/axa-products/retirement-planning/articles/understanding-defined-
benefit-plans.html (Accessed on 21st May 2018)
Murphy, M.C., Gerrans,P., & Speelman,C., (2014), What Drives Individuals’
Superannuation Investment Choices? Preliminary Evidence on Return Chasing,
Available at
https://www.researchgate.net/publication/267417585_What_Drives_Individuals'_Superan
nuation_Investment_Choices_Preliminary_Evidence_on_Return_Chasing (Accessed on
21st May 2018)