Factors For Choosing Between Defined Benefit Plan And Investment Choice Plan In Superannuation Essay.

A.What 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 may be important in this decision-making process? Explain.

B.“If the efficient-market hypothesis is true, the pension fund manager might as well select a portfolio with a pin.” Explain why this is not the case.

Defined Benefit Plan

The employees who are involved in the practices of providing the services are known as tertiary sector employees. Three types of sectors are available in the tertiary and the service sectors. Employees working in the service or tertiary sectors are required to make their own superannuation funds because they do not work under any employer¹. Employees working in the tertiary sector can select one of the two superannuation plans so as to manage their investments, these two plans are defined benefit plan and investment choice plans. Choosing the investment plans requires that the employees should take appropriate decisions in selecting the most effective plan, hence for analysis it is required that various factors should be taken into consideration². Firstly it is required these two plans should be properly understood and then the decisions for the selection of most appropriate plan should be taken.

Defined Benefit Plan: The plan in which the amount which will be received by the employee after the maturity is defined well in advance is known as defined benefit plan. This is the plan which has less risk involved in making the investment³. It is the plan which is based on the requirements of the employees in relation with the amount that will be received by them when the maturity of superannuation will occur or at the time when they will retire. This is the benefit plan in which contribution of both employer and the employee is being required in a specified amount. The contribution is based on various factors like salary of the employee, age, tenure of the service left and the number of years served by the employee in the company. Employer of the company also uses the defined benefit plan as the tool of increment. In the superannuation plan the final salary plan is also being decided with the help of which the pension of the employees is being evaluated.

There are three important variables attached with the defined benefit plan these are:

Pensionable services which is the number of the years for which the pension will be paid to the employees².

Pensionable earning which is the earning which will be drawn by the employees at the time of their retirements.

Accrual rate is the portion which will be received by the employees at the end of the years which are being selected in the scheme.

Formula that helps in calculating the pension income in defined benefit plan is:

Number of the year for which employee has worked x Salary that will be paid at the time of the retirement x accrual rate

It could be evaluated that there are various factors on which the pension funds that are being provided to the tertiary sector employees these factors are salary of the employee, number of year for which the services will be done, and the accrual rate of interest on which the employee will be working². But these are the superannuation funds in which the contribution can be made by the employees for which the funds will be received by the same in bulk at the time of superannuation. Various set of benefits are also being provided to the employees information related which is being provided to the employees at the time when the plan is being created. Defined benefit plan also provides tax benefits to the employees working in the tertiary sector.

Pensionable services

Unfunded benefit plans: Defined benefit plan also includes some of the funded benefit plans and some unfunded benefit plans for which it is required that the organization should make the decision for the same⁵. In unfunded defined plans investment in the assets is not being required. On the other hand in funded defined plans the investment is being made by the employees on the assets and the amount is being returned on the maturity of the superannuation by selling the asset. One of the major drawbacks attached with the funded defined benefit plan is that the amount that will be received by the employee at the time of maturity is not certain and cannot be estimated in advance.

Investment Choice Plan: The investment plan in which superannuation plan is provided and the investment account is to be activated with the investment company range of which starts from the amount planned to be investment by the employee are known as investment choice plan⁴. This is the investment plan in which the contribution related with the gain, interest, unit earnings for the period of the investment will be made altogether by the employee as well as employer. It is the investment plan in which employees have the power to change the investment plan according to their will and the situation of the market. One of the major advantages attached with the investment choice plan is that employees have the decisions making rights in managing the superannuation funds. Another advantage attached with the investment choice plan is that the portfolio could be made by the investment in relation which the type of investment that he is willing to make⁶. Some of the strategies which could be adopted by the employees for the purpose of using most appropriate investment choice plan. Some of the funds which could be taken into consideration in investment choice plan are secured funds, shares funds, stable funds and trustee’s selection funds.

Certain factors which are required to be taken into consideration by the tertiary sector employee while making investment decisions are:

Risk Profile: It is required that the level of risk should be properly analyzed by the employee before making any investment decisions. With the analysis it is being evaluated that defined benefit plan is the plan which includes less risk in comparison with the investment choice plan⁸. Reason behind defined benefit plan is less risky for the investment purpose because it is not directly linked with the market, on the other hand investment choice plan is directly linked with the market as there are certain finds like equity shares or various other fund which are directly linked with the activities of the market.

Inflation Rate: The cost of dearness or the living cost increases at the time of inflation. To make appropriate set of decision in relation with the investment it is required that superannuation contribution should be taken into consideration. Inflation provides an effective set of support to the employees in the defined benefit plan because these are the long term plans⁸. Defined benefit plans requires that the money should be invested for the long period of time and with the passing time value of the money keeps on declining hence more contribution is required from the employees in this plan.

Pensionable earning

Time Frame of Investment: It is necessary that while making the investment decisions time frame for which the investment are required to be made should be taken into consideration by the employees⁹. In case if an employee wants to make the investments for short period of time then he should choose investment choice plan and in case if he wants to make the investments for long period of time then he should invest in the defined benefit plans.

Financial Goals: Every individual available in the market has different set of financial goals. Certain financial considerations should be taken into consideration by the employee before selecting the superannuation plan¹⁰. In case if the financial goal of the employee is to generate more and more profit and is ready to take the risk for the same then he should invest investment choice plan. On the other hand of employees wants to generate moderate profit and is planning for the future incomes like pension then he should invest in defined benefit plans¹⁰.

Time value for the money is the concept which explains the fact that the value for the money keeps on decreases with the passing time. This is the concept which plays a very vital role in the selection of the appropriate superannuation contribution fund. Both the plans defined benefit plans as well as investment choice plans have different set of treatments and the mitigation processes which helps in managing the time value for the money¹¹. It is the aspect which is being used in making effective set of decision in relation with the superannuation funds. Time value for the money also helps in deciding the pension amount that will be provided after the maturity of superannuation or retirement of the employee. Some of the factors that help in providing better set of support to the time value for money are the inflation rate and the unpredictable market conditions.

It is the factor which will help in the calculation of net present value of the superannuation and the pension amount which will be received by the employees. Hence, this cause issue with the estimation of real cash flow which is cash inflow as well as outflow of the superannuation contribution occurs in this situation.

Efficient Market Hypothesis

The market situation in which the price of the commodity or the stock or the assets works as the reflection of the organization’s image in the market is known as efficient market hypothesis. In other words it could be said that the efficient market hypothesis is the situation in which the price of the entity’s stock and the shares are being decided by incorporating all set of information related with the organizations¹². It is the market situation in which the implications of the asset price or the stock prices are being done in the fair manner and assurance of the fairness of the same is made. It is the market situation in which the situation is being opposed on the basis of the factors like the price of the assets and various other aspects whose price keeps on changing according to the market¹³. Hence, it is the market condition in which the stock or shares for the purpose of investing could be purchased as it will provide relevant set of benefits to the party purchasing the same. It is the market condition in which past information related with the market, trend and various other considerations are not being undertaken as they have no effect on the investment made by the individual.

Accrual rate

Fund manager plays a very moderate role in the portfolio management. It s also possible that in portfolio management requirement of the pension fund manager could come to an end as there are no considerations that are required to be put by the pension manager in any  types of decisions regarding the portfolio¹³. In this situation it could be possible that the role of pension manager could get hampered and also could get diluted. Reason behind this is that in the efficient market hypothesis no consideration for the past information and the market happenings is being taken into consideration, hence no analysis will be required as well as help of the pension fund manager will also be not required in such situation. In the investment choice plan help of the pension fund manager could be taken as they will have to keep the track record and will have to remain updated in relation with the market conditions¹⁴. Hence, by evaluating all the aspects it could be said that no consideration of pension fund manager is required in the efficient market hypothesis Ceria.

But it is also being analyzed that such type of situation does not exist in the market and also chances of occurrence of such type of situations is very minimal in near future¹⁵. It could be said that efficient hypothesis market can never be the case in any of the market, as there are various market forces available in the market which are very strong and drives the market accordingly and also these forces have a huge impact on the value of the assets as well as shares in the market. It could also be analyzed that Efficient hypothesis is the situation in which no investor will be able to gain higher value.

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