Right Approach to Retirement
When designing a retirement plan, a wide range of risks, Employees need to know the options that can affect benefit amounts. For example, some plans allow an employee to get additional credit for service for unused sick leave and others may reduce the monthly benefit amount. An employee may provide services to an enterprise on a full-time, part-time, permanent, casual or temporary basis. For the purpose of this Standard, employees include whole-time directors and other management personnel. Employee benefits include:
(a) Short-term employee benefits, such as wages, salaries and social security contributions to an insurance company by an employer to pay for medical care, profit-sharing and bonuses nonmonetary benefits like medical care, etc.
(b) Post-employment benefits such as gratuity, pension, other retirement benefits, post-employment life insurance, and post-employment medical care;
(c) Other long-term employee benefits, including long-service leave or sabbatical leave, disability benefits and, profit-sharing, bonuses and deferred compensation
(d) Termination benefits.
Programmed withdrawals. A series of fixed or variable payments whereby the retiree draws down a part of the retirement capital. Any amount remaining in the retiree‘s account at his/her subsequent death belongs to the estate and is paid to the retiree‘s family and other beneficiaries. Under other arrangements, there is the risk of the capital being completely exhausted before death. The main forms of retirement payments allowed are lump-sums programmed withdrawals, and life annuities for as long as the retiree lives. Lump-sums are easy to administer, do not require complex calculations or record keeping, and the pension fund or plan sponsor relinquishes any subsequent obligation. For retiring plan members, lump-sums allow them to invest part of the money, pay down debt, satisfy the bequest motive, and give them the ability to self-annuitize. Moreover, problems of moral hazard arise as retirees can squander their assets and fall into the social security safety net. Finally, lump-sums do not protect from longevity risk. However, under programmed withdrawals there again remains the risk that the capital will be completely exhausted while the retiree is still alive.
Programmed withdrawals attempt to produce relatively stable annual income for the lifetime of the retiree. There are still many variations within this theme. Under the totally prescriptive approach, the amount to be withdrawn each year is calculated in accordance with a prescribed formula, and the annual withdrawal is exactly equal to this amount. Other countries set a minimum or a maximum limit on the amount that can be withdrawn. In some countries, programmed withdrawals are allowed or are even mandatory when the individual‘s retirement capital is too small to purchase a prescribed minimum amount of life annuity.
The present value of a life annuity. The retirement capital is divided by the present value of an equivalent life annuity. If the calculation is performed only, then the pension payments can be expected to remain constant, and the capital will eventually be depleted for those individuals who live to an advanced age. A stream of payments for as long as the retiree lives. There are also life annuities with additional guarantees, with continued payment to the surviving spouse, with the escalation of the benefits in payment, etc. The more common approach is for the calculation to be repeated each year for those who are still alive. There is then a constant re-spreading of the remaining, declining capital. At least, in theory, the capital will never be totally exhausted, but the payments in later years could become much smaller. There is always the hope that these reductions will be compensated by very positive investment performance, but again some of this positive effect could be lost by the negative effect of improving longevity. The significance of the discount rate used in these calculations also needs to be understood. In order to attempt to replicate a life annuity and to avoid frequent depletion of the retirement capital, this age is usually chosen as being beyond the average life expectancy at retirement (e.g. Canada allows an annuity certain to age 90). On this basis, only a very small percentage of the population will exhaust their funds while still alive.
Life expectancy. The retirement capital is divided by the expected future life expectancy of the annuitant and his/her cohorts. This calculation does not involve any discounting for interest, so it will not develop the same payments flow as the ―present value of a life annuity‖ approach. In a similar manner, and with comparable effects, practice differs as to whether the calculation is made only once at the beginning of annually throughout the individual‘s lifetime.
