ACTL3191/ECON3114/ACTL5002/ECON5114 Superannuation and Retirement Benefits

S1-2013

SUPERANNUATION AND RETIREMENT BENEFITS Session 1, 2013 Tutorial Program

Tutorial Week 3 (Week commencing Monday 18th March 2013) Topic 2: Alternative Models of Retirement Income Provision Tutorial Discussion Questions: 1) Does it matter whether a retirement income scheme is pre-funded or operates on a payas-you-go (PAYG) basis? In particular, consider: a) What factors affect the viability of a PAYG retirement income scheme? b) Would we expect the rate of return from a public funded scheme to exceed that from a public PAYG scheme? c) Does the rate of population growth matter? 2) Does it matter if a retirement income system provides benefits on a defined benefit basis or a defined contributions basis? In particular, consider: a) What are the key differences between defined benefit (DB) and defined contribution (DC) schemes? b) Compare the ability of DB and DC schemes to address the economic and financial risks faced by individuals in retirement. c) Using diagrams explain and discuss how defined benefit plans can be characterized as an exchange of options between employees and scheme sponsors (typically the employer)? d) DC schemes transfer risks from scheme sponsors to individuals. What are some other implications for individuals of membership of a DC retirement income scheme? 3) Imagine that you are a financial planner who specialises in advising Australian academics. Permanent hires to academe can join either a defined benefit (DB) plan, or an accumulation (defined contribution - DC) plan that offers members a choice of several different investment options, including Capital Stable, Balanced and Growth. In both the DB and DC plan the retirement benefit B is a lump sum. In the case of the DC plan, B is simply accumulated contributions plus investment earnings. In the case of the DB plan, on the other hand, the main component of B is defined by a multiplicative formula with three inputs: B = FAS M LSF where

ACTL3191/ECON3114/ACTL5002/ECON5114 Superannuation and Retirement Benefits

S1-2013

FAS M LSF

final average salary, in particular, average salary during the three years prior to retirement (or resignation) equivalent full-time years of service (i.e., adjusted for things such as leave without pay and part-time service) lump sum factor, which gradually increases with age. e.g., LSF stands at 0.21 for retirement or resignation at 55, rising to 0.23 for retirement at 65.

a) Calculate the value of B (your retirement benefit) for the values FAS = $70,000, M = 25 and LSF = 0.23. b) The average DB plan member will receive a payout comparable to what they would have received under the Balanced option for the DC plan. However, information provided to academics by UniSuper (www.unisuper.com.au) says that to the extent that you anticipate your resignation or retirement will be preceded by exceptional success with promotion committees, you should tend to prefer the DB plan over the DC plan. Is this good advice? Explain your answer. c) Compared to science academics, accounting/finance academics are less likely to be promoted but more likely to receive fixed-term salary supplements (especially early in their careers), and more likely to leave the university for careers downtown. Use these facts to help explain why the DB plan is much more popular with science academics than with accounting/finance academics. Essential Reading: Blake D (2000), Does it Matter What Type of Pension System You Have?, Economic Journal, 110: pp46-81. Highly Recommended Reading: Brown K, G Gallery and N Gallery (2004), Employees Choice of Superannuation Plan: Effects of Risk Transfer Costs, The Journal of Industrial Relations, 46(1): pp1-20. Supplementary Reading: Bodie Z, A J Marcus and R C Merton (1988), Defined Benefit versus Defined Contribution Pension Plans: What are the Real Trade-offs, in Bodie Z, J Shoven and A Wise (ed), Pensions in the US Economy, University of Chicago Press: pp139-62. Review Articles (for presentation in the Week 3 tutorial): Brown J and S Weisbenner (2007), Who chooses DC plans? NBER Working Paper 12842. Davis EP and Yu-Wei Hu (2008), Does Funding of Pensions Stimulate Economic Growth?, Journal of Pension Finance and Economics, 7(2):221249. Diamond P (1977), A framework for social security analysis, Journal of Public Economics, Volume 8, Issue 3, December 1977, pages 275298, M.I.T., Cambridge. Bodie Z, A J Marcus and R C Merton (1988), Defined Benefit versus Defined Contribution Pension Plans: What are the Real Trade-offs, in Bodie Z, J Shoven and A Wise (ed), Pensions in the US Economy, University of Chicago Press: pp139-62. 2