As mentioned earlier, the ambiguity of the future led to the nature of saving. Investing is another term used to describe this act. The rule of thumb in economics is that we invest to earn, not just to break-even or even lose money.
Nobody wants to be empty-handed, right? Therefore most people, as early as now, spares some money while they are still capable of working and earning money. There could be dozens of reasons why this is done, but the two most prevalent are: (1) to work hard now while they are still able, and this enables them to rest in the future; or (2) to have guaranteed money in the future, which the family could use for emergency purposes and even for everyday consumption.
With this reasons in mind, one of the most popular investing schemes is to invest in savings plans. This is because most, if not all, savings plans earn interest and secures your contributions for future use.
There are many kinds of savings plans such as retirement, educational, memorial, health, and others. With this wide variety of choices, where should one invest? Where would one maximize his utility? Where the returns would be maximized?
Given this problems on where a person should invest, this paper would try to answer the mentioned questions, focusing on the retirement and educational plans. The two is quite interesting to focus on because they are the most popular, and most people engaging in investing in this type of venture chooses this two. Also, the mentioned two are the ones that cater to almost all individuals (because almost all people have a family member or two who wants to study in college, and almost all people are also working but their jobs are not permanent because they will eventually get old or even be ill).
Background of the topic
Retirement plan, also known as pension plan, is a benefit plan for the employees, which is either kept by the employer, or by a workers’ union, or sometimes even both. Pension provides retirement income or postpones income in anticipation of termination of covered employment or even beyond. There are various types of the said pension plan. Some of which include the 401 (k) plans, and the traditional pension plans (also referred to as defined benefit plan). (Retirement Plans, Benefits & Savings, 2007)
Specifically, a 401 (k) plan is a retirement savings plan that is financed by the employee himself through contributions, with a corresponding contribution from the employer as well. This means that what the employee contributes to his pension, his employer would also contribute the same amount of money to that employer’s pension. Most people sought after this kind of retirement plan because contributions are taken from the pre-tax salary, and the funds grow tax-free until it is pulled out. With this, the contributor is ensured that every penny that he contributes to his pension would eventually go back to his pocket in the future. In addition, the 401 (k) plans can be utilized by both profit and tax-exempt organizations for their employees. (Nieters et al., 2005)
On the other hand, there is a 529 plan, which is an educational savings plan. This is run by a country or educational institution that is intended to aid families save money for future college costs. If the plan passed a few basic requirements, the federal tax law gives special tax benefits to the plan participant. (“What is a 529 plan?” 2007)
Consequently, there exist certain savings plans that are tax-free until the bearer of the plan reaches post-secondary education. This type of plan is called a Registered Education Savings Plan (RESP). Also, this type of plans are an efficient way of saving money for future college education because it is not only limited to tuition fees, but it can also be used in residential and other educational expenses that the child may encounter in the future. (What is a Registered Education Savings Plan and why should every Canadian child have one?, 2007)
Financial Theory applicable
Finance theory is the field that deals with investment making decisions, as well as the time concept of money.
In this specific example, perhaps the most applicable financial theory would be the theory of annuity.
Annuity is a financial product, in this case the savings plan, sold by certain financial institutions that is made to receive and raise funds from an individual, which is the planner/contributor, and then, upon annuitization, pay out a flow of payments to the individual at a specified point in time. These are utilized as measures of securing a steady cash flow for an individual either during retirement years or when one reaches college. (“Annuity,” 2007)
In other words, this annuity theory is all about guaranteeing the plan-holder of enough money that he could utilize for future’s consumption either in education or as pension.
Analysis in relation to the theory selected
Like any other savings plan, retirement or pension plans are paid on a monthly basis. However, there are exemptions to this rule, i.e. those who have a monthly benefit of only $50 or less, their contributions is paid yearly. Most planners prefer a lump sum distribution, especially if the full value of the benefit is $5000 or less. (Pension Guarantees) In the concept of annuity, these payments are the initial contributions made by an individual.
However, the flow of payments during a specified amount of time is as follows: Under the single-employer program, the maximum guarantee is $49500 annually or $4125 monthly for a single-life annuity beginning at age 65. (Pension Guarantees)
On the other hand, in relation to educational plans, the contribution is a maximum of $2000/year per student. With this, the money that he will get in the future ranges from $95000-$110000 for single filers, or $190000-$220000 for joint filers. However, if the income is used by a person other than the beneficiary and is in turn withdrawn, the tax exemption would be terminated and the earnings are already subject to a 10% penalty. (“Coverdell Education Savings Accounts,” 2007)
With the facts presented above, where should one invest his money?
Invest in a Retirement Plan
It is quite obvious that its benefits include having guaranteed money that a person could use once he does not have a job anymore. It is quite remarkable to have this type of savings plan because all workers would eventually be laid off because of old age, sickness, etc. Having a retirement plan, his and his family’s future is secured that even if the planner/contributor would not have a job in the future, the family would receive certain amounts of money either annually or monthly. Also, another advantage of investing in a retirement plan, especially in a 401 (k) plan, is that not only the employee contributes to the pension, but the employer also contributes the same amount of money to the pension plan of his worker. Given this premise, the employee would be more encouraged to work in his employer because he contributes to his pension too. Consequently, the employer would be ensured that the said employee would be loyal to him, and would work even more efficiently and effectively due to the benefits that the company is giving to him. A third advantage is that the contributions are deducted from a pre-tax salary. This means that a lesser amount is to be deducted to the employee’s salary. This means that while the employee is still contributing, up to the day that he would receive his pension, no tax would be charged to the said pension holder. Lastly, another advantage of investing in a retirement plan is that the contributions of the employee can be used in various ways. This means that he is free to choose on the ways to spend the said money upon receiving it. The money could be utilized for everyday consumption of goods and services, emergency purposes, education, etc.
On the other hand, one of the disadvantages of engaging in a retirement plan is that the monthly contribution is quite relatively high compared to other plans. With this, the family would be deprived of certain benefits while they are still contributing to the pension. Some of the deprived benefits include lesser money for consuming goods and services, lesser money that can be used to invest in other business ventures, etc. Also, the rate of return from pension plans is quite relatively low compared to other plans. Due to this negative impact, some choose other alternative savings plan like that of the educational savings plan.
Invest in an Educational Plan
In terms of educational planning investment, its advantages include a more secured educational future for a child. With this, the parents of the child would not have to worry about anything in the future. The bearer of the educational plan is already ensured that he would have money to pay for his tuition, books, dormitory, etc. Also, another advantage of engaging in this kind of savings planning is that if the planners were able to meet certain requirements, they would be tax exempted as well. This means that the contributions that they would give to the financial institution sponsoring the educational plan all goes to the money of the child to be used for his college education. The third advantage of this plan is that it is not only for the child’s tuition, but also for the dorm and other educational needs. With this diversity in education-related payments, the child would have fewer things to worry about when he is in college. Lastly, the there is a higher rate of return when a person engages in this kind of venture, especially if it is joint (meaning, not only one child is being ensured by the educational plan).
However, there are certain disadvantages to this type of savings planning. One of which is that the plan is only limited to education. What if the family experiences certain emergencies in the future and they have no other means of acquiring money? Although they could still withdraw the money, however, the child will suffer because this action would entail a lower return to him and even a penalty.
Given the pros and cons of the two choices, where should one invest his money?
This all boil down to the tastes and preferences of the consumer. For instance, if he prefers a more secured future for the entire family, then a retirement plan is indeed a smart choice. But, if he cares more for his children’s future and he knows that he is still capable of supporting the entire family even if he is quite old already, then the educational plan is just right for him.
However, for the sake of this paper, using a cost-benefit analysis, which is weighing the advantages against the disadvantages, then it, is safe to say that the right savings plan to engage in is the retirement plan.
The said alternative was chosen because the advantages that it offers are relatively superior to that of the educational plans. Also, it is more diversified therefore, could cater to all the future needs of a family. In addition, any member of the family could withdraw the pension (given ample requirements to meet) but they would not have to endure any penalties.
Although there are disadvantages, still, the benefits do outweigh the costs. For instance, the relatively low rate of return is tolerable because it is quite enough to support the needs of the entire household.
Therefore, I advise everyone to engage in retirement plan as early as now.