Quiz 1: The Dynamic Ongoing Evolution of Private Retirement Plans

Business

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Economic Problems basically refers to the financial problems faced by individuals during their lifespan. With age, comes retirement which results in permanent leaving of workforce such that an individual relies upon his savings and benefits through social security and other employer benefit programme invested in for its daily expenses. This phase is quite tough period as with age, earning capacity decreases but the expenses remain same. Few basic economic problems faced by aging individuals are- 1.  Standard of living after retirement. It is commonly assumed that with retirement, the expenses of an individual decreases because of diversion of responsibility however this is not completely correct as most of the individual's expenses increases because of the custodial care they usually need with increasing age and also the increased inflation might result in the same standard of living to be more expensive which does not allow the idea of retirement to be related with the reduced expenses due to low standard of living. 2.  Employment Opportunities. Individual sometimes lack adequate savings for them to retire and meet their expenses and as such they are forced to work even after 65 years of age (normal retirement age) to maintain their standard of livings but this is also not very helpful as most individual due to physical or mental inefficiency are not provided with adequate employment opportunities. Also technological advancement, retirement plans etc. has added to the problem by making 65 years of age a bar for an individual after which employment opportunities for individual decline to a great extent. 3.  Individual savings Individual are required to save more for their old age in various retirement plan so as to maintain a substantial standard of living without depleting their accumulated savings. For the purpose of the same, many retirement plans and laws regulating them has been established by the government so that this could encourage individuals to save adequately for their older self. 4.  Increasing Longevity Individuals living longer than expected faces the economic problem of continuing to meet their daily expenses. Usually during the earning period, individuals save money has per an expected life age after retirement but most of the times the actual age surpasses this expected age and results in depletion of accumulated savings leading to a huge problem for individual to survive. These are the basic economic problems faced by an individual in aging years after retirement.

If students are not familiar with present value techniques it is probably best to start with a relatively simple example. Assume an employee is age 60, plans to retire with a lump-sum distribution at age 65, and elects to defer $100 of compensation at the beginning of the year. If a tax rate of 28 percent is paid on taxable income immediately upon receipt and investments pay interest of 10 percent at the end of the year, the employee will have an extra $161.05 ($100 x 1.1 5 ) in the pension plan at retirement. After paying taxes of $45.09 (.28 x $161.05), an amount of $115.96 ($161.05 - $45.09) remains. In contrast, if the $100 was taken in wages, the employee would have paid $28 in taxes and received only $72 to invest. At the end of the first year, that amount would have accumulated to $79.20 ($72 x 1.1); however, taxes on the investment income of $7.20 amount to an additional $2.02, leaving the employee with $77.18 to invest the next year. After five years, the employee would have accumulated $101.93 ($72 x (1 +.1 x (1 -.28)) 5 ). The difference of $14.03 represents more than 12 percent of the after-tax pension distribution. This demonstrates that pensions continue to have important tax advantages, even in a flat-tax world. This example only looked at the relative tax advantage of a single year's contribution. In reality, a pension plan consists of an entire career's worth of contributions. Ippolito calculates the tax-exempt earnings benefits of private pensions assuming a constant pension savings rate over a 30-year period. [5]   Although the math is beyond the scope of an introductory pension course, the results are worth noting. Assuming an interest rate of 8 percent and a flat tax rate of 25 percent, the tax gain from the interest tax exemption was 18.6 percent of pension income. This represents the portion of (before-tax) pension retirement income that would otherwise have been collected as tax on interest earnings if the same pension contributions had been saved outside the tax-exempt pension plan.

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