Importance of Superannuation Contributions in Corporate Finance

Question: Discuss about the Importance of Superannuation Contributions. Answer: Introduction This report aims to provide an understanding of the importance of superannuation contributions in the tertiary sector employees. In this context, the report discusses the factors that should be taken into consideration by the tertiary sector employees when they are placing their superannuation contributions in the defined benefit plan or investment choice plan. The superannuation is described as an organizational pension program that is developed by business corporations for promoting employees welfare. The major benefit of superannuation pension program to the employees is that funds deposited in the account are not subjected to any tax implications till the withdrawal or retirement of employees. There has been increasing emphasizes of business corporations to incorporate superannuation in the employees benefit plan for encouraging them to save for their future years. The government of various countries is focusing on minimizing the contributions to be made into superannuation pensi on program by employers for ensuring employees welfare (Graney, 2004). The comparison of defined benefit plan and investment choice plan is discussed in the present report in order to analyze their benefits for employees. Also, the report examines the issues relating to the concept of time value of money while taking decisions regarding the selection of superannuation contributions to be done in defined benefit or investment choice plan. In addition to this, the report discusses the role of efficient-market hypothesis for pension fund manager in selection of a portfolio. Factors to be considered by Tertiary Sector Employees to place their superannuation contributions in the Defined benefit or Investment Choice plan The tertiary sector is referred to as service sector and comes after the secondary manufacturing and primary raw materials economic sectors. The tertiary sector employees are the service sector employees and they receive superannuation contributions on the basis of their appointment. The superannuation contributions refer to the retirement pension plan that is determined by an organization for its employees benefits. The superannuation contributions are made either by the company known as defied benefit plan or by the employees referred to as defined contribution plan. The funds deposited in the retirement plan through superannuation contributions are subjected to grow in value till the retirement of employees. The minimum contribution to the superannuation was initially 3 per cent but has increased to about 9 per cent for the tertiary sector employees. The superannuation contributions plan is highly beneficial for the employees as it is supported by the government and thus employers have to pay a minimum percentage of salary proportion to the retirement scheme for employees (Smith and Koken, 2011). The minimum mandatory contribution made by the employers on behalf of employees is referred to as superannuation guarantee. Also, the employees are compelled to contribute a minimum percentage of their income to retirement plan under superannuation guarantee. The main reason behind the mandatory contribution in superannuation by employers and employees is to remove any unnecessary burden on the social security system by saving the funds for the employees future life period. The superannuation and mutual funds have thus become biggest investors in financial system of Australia due to large amount of funds contributed by employers and employees in this scheme. The organization known as Uni Super Ltd is known for managing the superannuation plan for tertiary sector employees within Australia (CCH Australia Staff, 2012). There are two major types of investment choice under the superannuation contributions that are, Defined Benefit Plan and Investment Choice plan (Graney, 2004). The benef its offered under both the above mentioned investment choice is explained as follows: Defined benefit plan is referred to as retirement plan offered to employees by the employers in which employers are required to provide a specified amount of funds to the employees as their pension funds. The specified amount of funds promised to be provided by the employer is calculated through a formula incorporating the use of employees salary, age and employment period. The tertiary service sector employees can determine their superannuation in advance in the defined benefit plan as it is determined on the basis of a formula (Kolb, 2009). The funds invested in the defined benefit plan are allocated to different assets as decided by the trustees of UniSuper Ltd. The main benefit for tertiary sector employees adopting the define benefit plan is that it is associated with less risk as the final payment received by the employees is fixed without the effect of performance of asset portfolio. However, this also proves to be drawback of the benefit plan as employees cant gain funds high er than the minimum payout determined by the formula (Reilly and Estreicher, 2010). On the contrary, investment choice plan provides investment choices to the employees and thus employees can select the best possible strategies for their investment as per their needs. The employees are provided the complete authority to decide about the type of assets or portfolios in which the superannuation contributions are to be done (Reilly and Estreicher, 2010). The employees are offered the following fur types of investment strategies in the investment choice plan as follows: Secure Fund: These consist of securities with fixed interest and cash. Stable Fund: It consists of bonds and also some opportunities to invest in domestic and overseas share. Choice of Trustees: It includes domestic and overseas shares, property assets, private equities and investment in infrastructure. Shares Funds: It consists of completely investing in domestic and overseas shares (Maginn et al., 2007). The employees can select from either of the above mentioned strategies on the basis of risk and return factors associated with each of the options. Thus, the employees who select to invest their superannuation contribution under the investment choice plan have to analyze the risks and return characteristics of each of the strategies. The final payment received under this plan is not fixed and cannot be determined in advance as it is dependent on the investment strategy selected by the employees. Therefore, all these factors need to be considered by the tertiary sector employees at the time of deciding their superannuation contributions in the defined benefit plan or investment choice plan. The employees who possess sound knowledge of investing in risky portfolio can select investment choice plan while who have limited knowledge of funds investment should invest in defined benefit plan (Graney, 2004). Issues Relating To the Concept of the Time Value of Money in This Decision-Making Process The concept of time value of money is very important at the time of taking critical financial decisions. This concept helps a finance manager to take critical decisions in relation to investment and financing. The tertiary sector employees can take decisions relating to place their superannuation contributions in the defined benefit plan or investment choice plan. The concept of time value of money will help in determining the cash flows that will be arise at a future period of time. This is done though using two methods that are, compounding the present money to future date or discounting the future money to present date. As such, this concept can be taken into account by the employees while selecting whether they have to receive money in lump sum or in definite payouts at fixed intervals of time from their pension plan (Gitman et al., 2015). The decisions can be taken easily using the concept of time value of money that helps in comparing the value of present and future money. As discussed above, defined benefit plan involves providing definite payout to employees at the time of their retirement that is calculated on the basis of a fixed formula. Thus, employees can use the concept of time value of money while calculating the future amount that they are likely to receive in the future period of time through compounding the present money to future date through the technique of compounding provided by the concept of time of value of money (Wendt, 2015). On the other hand, the investment choice plan the amount received by the employees from the pension plan is related to the performance of the portfolio in which they select to invest. The employees can utilize the concept of time value of money to determine the future cash flows that they are likely to receive from investing in different type of assets. The amount obtained from investment choice plan is dependent on the risk and return characteristics of the type of portfolio selected by the employees. The time value of money will help in assessing the possible return that can be generated from selecting a specific strategy under investment choice plan and thus deciding the worth of money in the future period of time. The future value of the periodic cash flows that will be received under investment choice plan can be easily determined through the use of time value of money. Therefore, the employees can analyze the future cash flows that they will receive under defined benefit or investment choice plan and thus can take decisions relating to place their superannuation contributions in the defined benefit or investment choice plan (Petty et al., 2015). 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 The efficient market hypothesis (EMH) is an investment theory as per which the price of an asset at a time determines all its information. Thus, the theory of efficient-market hypothesis assumes that investors receive all the available information about assets in the same manner. Thus, as per the theory investors are likely to receive equal returns with equal amount of investment done on an asset as they receive same information. The theory has been a subject of debate since its establishment as the view provided by the theory that markets operate efficiently and price of assets states all the information available about them is severely criticized. This is because is this is case it would be rather impossible to beat the market and as such investors would not be able to gain higher returns (Bergen, 2011). The role of pension fund manager is very important in order to ensure that pension plans of employees operate in an effective manner. The main responsibility of pension fund manage r is to provide maximum benefits to employees with their pension scheme after their regiment by investing in right type of assets. Thus, they have to select a portfolio for their employees that are likely to provide them maximum returns in the future. Thus, developing a portfolio associated with minimum risk and maximum performance is the main reasonability of a pension fund manager (Fiestas et al., 2010). However, if the financial economic theory of efficient-market hypothesis is true, then generating a portfolio with maximum returns would be relatively an easy task for pension fund manager. The pension fund manager can easily select assets that are likely to yield maximum returns as the asset prices reflect all the possible information about them. However, this is not the case, a pension fund manager have to develop a portfolio that can provide maximum returns by diversification of the market risk. As such, a pension fund manger have to invest in different type of assets that have low co-relation between them in order to diversify the investment risk and maximize the returns generated from a portfolio. The selection of right type of assets under a portfolio is the most difficult task for a pension fund manager. Lower the co-relation between assets, lesser is the risk because if one asset provides lower returns then other assets can yield higher returns. However, if the efficient-mark et hypothesis is believed to be true than pension fund manager have not to diversify the risk of a portfolio as all assets generate same type of returns (Wendt, 2015). Conclusion Thus, it is inferred from the overall discussion held in the report that tertiary sector employees should carefully analyze the future cash flows that can be generated through placing their superannuation contributions in the defined benefit or investment choice plan through the use of time value of money. The pension fund manager has to select a portfolio for their clients that will provide them maximum returns and is associated with less risk. References Bergen, J.V. 2011. Efficient Market Hypothesis: Is The Stock Market Efficient? Retrieved May 13, 2014, from Available at: https://www.forbes.com/sites/investopedia/2011/01/12/efficient-market-hypothesis-is-the-stock-market-efficient/#4a55338176a6 CCH Australia Staff. 2012. Australian Master Tax Guide. CCH Australia Limited. Fiestas, H.V. et al. 2010. Better Returns in a Better World: Responsible investment - overcoming the barriers and seeing the returns. Oxfam. Gitman, L. J. et al. 2015. Principles of Managerial Finance. Pearson Higher Education AU. Graney, P. J. 2004. Retirement Savings Plans. Nova Publishers. Kolb, R.W. 2009. Corporate Retirement Security: Social and Ethical Issues. John Wiley Sons. Maginn, J. L. et al. 2007. Managing Investment Portfolios: A Dynamic Process. John Wiley Sons. Petty, J. W. et al. 2015. Financial Management: Principles and Applications. Pearson Higher Education AU. Reilly, D. and Estreicher, S. 2010. Employee Benefits and Executive Compensation: Proceedings of the New York University 59th Annual Conference on Labor. Kluwer Law International. Smith, B. and Koken, E. 2011. The Superannuation Handbook 2008-09. John Wiley Sons. Wendt, K. 2015. Responsible Investment Banking: Risk Management Frameworks, Sustainable Financial Innovation and Softlaw Standards. Springer.