Managing Human Resource – Bohlander, Snell, Sherman
- Social security provides 3 types of benefits payable if employee is insured under the Social Security Act:
ü Retirement income at the age of 62 and thereafter
ü Survivor’s or death benefits payable to the employee’s dependents regardless of age at time of death
ü Disability benefits payable to disabled employees and their dependents
- The Medicare program, which provides a wide range of health services to people 65 or over, is also administered through the Social Security system.
- Social Security is paid for by a tax on the employee’s wages, shared equally by employees and employer. If you are self-employed, you pay the entire sum less 2% of your self-employment income.
- Types of pension plans:
ü Defined benefit pension plan: contains a formula for determining retirement benefits.
ü Defined contribution plan: employer’s contribution to employees’ retirement or saving funds is specified. The benefits depend on both the amounts contributed to the fund and the retirement fund’s investment earnings. The contributions may be made through profit sharing, thrift plans, matches of employee contributions, employer-sponsored Individual Retirement Accounts (IRAs).
ü 401(k) plan:
v Based on Section 401(k) of the Internal Revenue Code, employees can have a portion of their compensation (which would otherwise be paid in cash) put into a company profit-sharing or stock bonus plan by the employer. This results in a pretax reduction in salary. so the employee isn’t taxed on those set-aside dollars until after she retires (or removes the money from the pension fund)
v Some employers may match a portion of what the employee contributes to the 401(k) plan (contributory plan) or may not match (noncontributory plan). Employers usually choose 401(k) providers (such as investment firms) to set up and administer their 401(k) plan.
v To encourage employees to save for retirement, some employers are making enrollment in their 401(k) mandatory
v Who qualifies: Employees at least 1 years old having one year of service
v Who benefits most: people in plans with generous term, such as matching contributions from employer
v How much can be saved each year: tax-deferred up to $10,000, or the maximum permitted by your plan. After-tax, if allowed: up to the maximum permitted by your plan, but combined savings can’t top $30,000 or 25% of pay
v Contributions are tax-deferred and some plans also allow after tax savings.
v Rollovers permitted into IRAs and other qualified plans.
v How are withdrawals taxed: Ordinary income-tax rates apply to withdrawals of tax-deferred contributions and any investment earnings. No tax on withdrawals of after-tax contributions, loans from your account, or rollovers an IRA or new employer’s 401(k)
v Penalties for early withdrawals: Additional 10% tax on withdrawals made before age 59 ½.
v Exceptions to penalties – early withdrawals made: (1) By your beneficiaries at your death (2) By diagnosis of severe disability (3) To pay medical expenses in excess of 7.5% of gross income (4) In equal installments intended to last the rest of your life (5) Upon leaving your job after age 55.
v Minimum-distribution rules: Employees can continue to contribute as long as they’re working. But if you are a 5% or more owner or retired, you generally must begin withdrawing money from the plan by April 1 of the year after you turn 70 ½. The minimum payout depends on your life expectancy or the joint life expectancy of you and a beneficiary.
v If your plan offers loans, you can get quick access to your savings by borrowing against your account.
ü Deferred profit-sharing plan: employers typically contribute a portion of their profits to the pension fund, regardless of the level of employee contribution
ü An employee stock ownership plan (ESOP): a qualified, tax-deductible stock bonus plan in which employers contribute stock to a trust for eventual use by employees
- According to Employee Retirement Income Security Act, pension funds are vested funds – the money that have been placed cannot be forfeited for any reason.
- According to the Pension Benefit Guarantee Corporation (PBGC), more and more employers are terminating their defined benefit plans and replacing them with uninsured defined contribution. One reason for this is that the accounting profession’s “Employers Accounting for Pensions” rule (FASB 87), requires employers with defined benefits plans to estimate on their balance sheets the size of the employers’ liability.
- Golden offerings: offers to current employees aimed at encouraging them to retire early, perhaps even with the same pensions they would expect if they retired at age 65. Early retirement window: a type of golden offering by which employees are encouraged to retire early, the incentive being liberal pension benefits plus a cash payment.
Questions:
- Should we stimulate risk for a pension fund itself?
- Should we stimulate a case against Milevsky ‘s conclusion about a bond-type person should borrow to increase stock exposure?
The Role of Annuity Markets in Financing Retirement – 2001 – Jeffrey R. Brown, Olivia S. Mitchell, James M. Poterba, Mark J. Warshawsky
Distinguish annuities along:
ü Time of payment: (1) Immediate annuities: Begin making payment immediately after the payment of the premium (2) Deferred annuities: do not make payments until some date in the future. Deferred annuities receive favorable tax treatment during the accumulation phase, and in many cases it is possible to withdraw assets from these annuities without conversion to a life-long income stream. Before the payments commence, the premium dollars can be invested at a fixed rate or in a portfolio of risky assets (variable annuity).
ü Number of lives covered
ü Bequest option
ü Period certain guarantees (or refund option): provide some additional payments to a beneficiary in the event that the insured individual dies shortly after annuitization.
ü Type of payout: (1) Fixed nominal annuities: offer payments that are constant in nominal terms (2) Graded annuties: increase at a predetermined percentage rate (3) Inflation-indexed annuities: Rise with the rate of inflation (4) Variable annuity: payouts are linked to an underlying portfolio of assets, and will rise and fall according to a predetermined relationship with that portfolio’s value.
Factors that lead people to annuitize less than their full wealth:
ü Leave a bequest
ü Uncertainty about uninsured medical and long-term care needs or other potential expenditures
ü Desire for liquidity and control
ü Various capital market imperfections
Money’s worth of an annuity:
ü The ratio of the expected discounted value of its future payments to its initial purchase price (or policy premium). Calculations depend on the annuity payout amounts available in the private market, mortality rates and interest rates.
ü Useful for determining the degree to which private market annuity prices deviate from their actuarially fair level
ü Useful to decompose differences between a money’s worth values and the actual observed money’s worth value into a component attributable to adiminstrative costs and a component due to differences between the life expectancy of annuitants and that of the general population (adverse selection).
Utility-based annuity indicators: How an annuity might be valued by a risk averse life-cycle individual or couple. Objective: To gauge the economic value of annuitization by comparing utility levels with and without an annuity market.
ü Wealth equivalence: An individual starts off with wealth outside an annuity and has no access to annuity markets (cannot purchase an annuity). The wealth equivalence is the fraction of wealth that the individual would require to achieve the same level of utility that he attains with his nonannuitized money, if she instead devoted this fraction of his wealth to annuity. This indicator is smaller than 1 for risk averse person as annuity provide a valuable form of insurance.
ü Annuity equivalent wealth: This indicator assumes that an individual has an amount of fully annuitized wealth and then considers the consequences of closing the annuity markets. How much the individual’s wealth would need in order to generate the same utility level without annuities.
Annuity Markets and Pension Reform – George A. (Sandy) MacKenzie
Principal forms annuities can take
Duration of distribution phase
ü Life only or whole annuity – the annuitant’s post-annuitization lifetime
ü Certain annuity – a fixed period, whether or not the annuitant lives to the end of it
ü Temporary annuity – the shorter of a specified period and the annuitant’s post-annuitization lifetime.
Form regular payment
ü Level (fixed in nominal terms)
ü Fixed initially in norminal terms, with periodic step increases at a predetermined rate (titled, escalating, or rising)
ü Variable
§ Minimum payment guaranteed
§ Minimum payment guaranteed with increases irreversible
§ Variable payment depending on performance of underlying assets (investment risk borned entirely by annuitant)
§ With profit
ü Indexed
§ Indexed with cap on increase in percentage terms (limited price indexed)
§ Fully indexed (index-linked)
Premium payment arrangements
ü Immediate single payment
ü Regular payments (for a deferred annuity)
Timing of income payments
ü Immediate (payments commence at the end of the first period after annuitization, usually a month)
ü Deferred (payments begin some time after annuitization)
Rights of survivorship
ü Single life (where payments cease upon the annuitant’s death)
ü Joint-life annuity (where payemnts cease when one of the lives covered dies)
ü Joint-survivor annuity (payments (usually reduced) continue until the death of the second life; with symmetric joint-life annuity, payment is the same regardless of which spouse survives; with contingent annuity, payment to one may be lower than to the other)
Guarantee features
ü Certain and life (period-certain) annuity – payments are made for a minimum specified period, even if the annuitant dies before the period ands
ü Refund of premium annuity – payments are made until their sum equals the value of the premium
Other
ü Impaired lives
Annuity markets – Edmund Cannon and Ian Tonks
Additional to longevity risk and investment risk, there are three sources of retirement income risk faced by individuals: (a) replacement rate inadequacy, since their savings may be insufficient to maintain an adequate standard of living in retirement (b) social security risk: if the government changes the retirement benefit system (c) inflation risk
Three ways of accessing retirement funds: (1) as a lump sum (2) phased withdrawals: with limits on the amounts of the funds that the pensioner can access (3) annuitization
