Lecture 10

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CONTENTS

I. Introduction to retirement planning

II. Social security (Vietnam)

III. Pension plans & Retirement programs

IV. Annuities

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Introduction to Retirement Planning
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What and why?
• Definition:

Retirement planning is the process of determining retirement income goals

and the actions and decisions necessary to achieve those goals.
(Investopedia)

• Roles in personal financial planning:

 Enable a comfortable standard of living in retirement.
 Affect both current and future standard of living.
 Relate to tax planning and investment planning

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Steps in retirement planning
I. Set retirement goals

• Determine future retirement needs

• Estimate retirement income
• Determine the shortfall’s future value
• Funding the short falls

II. Formulate an investment program

• Create a systematic saving plan

• Identify the types of investment vehicles

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Three biggest pitfalls in retirement planning
1. Start too late
2. Put away too little
3. Invest too conservatively

Compounding essentially magnifies the impact of

these mistakes !!!

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Compounding effect illustration
Savings started at Savings started at
25 years old 35 years old
Annual savings $2000 $2000
Saving rate 6% 6%
Time until retirement at 65 40 years 30 years
Accumulated amount $309,000 $160,000

1. Accept higher risk investment opportunities

2. Lengthen your investment period
3. Contribute more each year (cut current spending)
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Social security in Vietnam
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Benefits

Work injury
&
Sickness Occupational Old-age Survivor’s
Disease

Medical
Unemploy
Maternity (Health
-ment
Insurance)

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Old-age benefit
1. Eligibility conditions:
• The age of pension entitlement: 55 (for women), and 60 (for men)
https://thuvienphapluat.vn/tintuc/vn/thoi-su-phap-luat/chinh-sach-
moi/30447/dieu-kien-huong-luong-huu-chi-tiet-tu-01-01-2021-ai-cung-can-biet
NOTE: Those who have worked 15 years in hazardous and dangerous occupations are
deducted 5 years.
• Have paid insurance premiums for at least 20 years.
2. Monthly retirement pension:
• Maximum pension: 75% of the average monthly salary.
• Minimum pension: the basic minimum wage.
 45% for the first 20 years of contribution
 Each additional year of contribution, the additional reimbursement rate is 2%

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Monthly pension payment - Example
Mr. Hung, a financial chief officer, has recently retired (2020). He has
paid social insurance premiums for 28 years.

His pension payment rate will be:

His monthly pension payment will be 61% of his average monthly

salary (since he started paying social insurance premiums)

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Survivor’s benefit
FUNERAL ALLOWANCE & DEATH GRATUITY
FUNERAL ALLOWANCE:
• 10 months of the basic minimum wage.
• Eligibility conditions:
The deceased insured has contributed to the social insurance fund for at
least 12 months.
The deceased insured dies of work injury and occupational disease.
The deceased insured is receiving monthly retirement pensions.
The deceased insured is receiving monthly work injury and occupational
disease benefits.

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Survivor’s benefit
DEATH GRATUITY:
• Relatives of the deceased insured who:
having contributed to the social insurance fund for at least 15 years but has
not been provided with one-off allowances;
is receiving monthly retirement pensions;
is receiving monthly work injury and occupational disease benefits of at least
61% incapacity;
dies of work injury and occupational disease;
are eligible for monthly or one-off death gratuity.

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Survivor’s benefit (cont.)
• Monthly gratuity for each dependent:
50% of the basic wage
70% of the basic wage if the dependent has no direct raiser.
No more than 4 persons.
• One-off death gratuity:
Calculated based on the duration of social insurance contribution.
For each year of contribution before 2014, relatives of the deceased are
entitled to 1.5 times the insured’s average monthly salary.
For each year of contribution from 2014 forward, relatives of the deceased
are entitled to 2 times the insured’s average monthly salary.
Minimum level: 3 times of the insured’s average monthly salary.

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One-off death gratuity - Example
• Mr. An had paid social insurance premiums for 15 years. He died on
20 July 2018 due to a car accident. He has a son (20 year-old). His
wife works a kindergarten teacher and her salary is higher than the
minimum wage.
• Mr. An’s average monthly salary (used to determine his monthly social
insurance premium): 4,100,000 VND

Death gratuity = (11 x 1.5 + 4.5 x 2) x 4,100,000 = $104,550,000 VND

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Employer-sponsored pension plans
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Employer-sponsored programs

Employer-sponsored programs

Supplemental
Basic plans
plans

Non- Salary
Contributory Profit sharing Thrift and
contributory reduction
pension plans plans savings plans
pension plans plans

Defined Defined
Cash-balance Qualified
contribution benefit plans
plans pension plans
plans (DCP) (DBP)

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Employer-sponsored programs
• NONCONTRIBUTORY PENSION PLAN:
• The employer pays the total cost of the benefits.
• The employee doesn’t have to pay a thing.
• CONTRIBUTORY PENSION PLAN:
• The employer and the employee share the cost.
• The most common arrangement is for the employer to match the employee’s
contribution.
• The trend is toward contributory plans.

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Defined Contribution Plan (DCP)
• Tax-deferred retirement plan in which employees contribute a fixed
amount or percentage of their paychecks to an account that is intended to
fund their retirement.
• The company will match a portion of employee contribution as an added
benefit.
• There is no way to know how much a DC plan will ultimately give the
employee upon retiring, as contribution levels can change, and the returns
on the investments may go up and down over the years..
=> Employee bears the risk of funding retirement.
• Income tax will ultimately be paid on withdrawals, but not until retirement
age

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Defined Benefit Plan (DBP)
• Guaranteed retirement benefits for employees & largely funded by
employers, with retirement payouts based on a set formula that considers
an employee’s salary, age and tenure … with the company.
• Benefits are paid out regardless of the plan's investment performance.
Example:
Benefits =2.5% of their final 3-year average annual salary for each year of
service.
Final 3-year average annual salary = $85,000
Years of employment = 20 years
Benefits = 2.5% x 20 x $85,000 =$42,500
• Investment performance falls short => employer must make up the
difference => employer bears the risk.
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Cash-balance Plan
• A hybrid of traditional DBP and DCP:
• Features of DBP:
• Employer makes all contributions & controls the investments.
• Employer guarantees a benefit payout at retirement.
• Features of DCP:
• The contributions are based on a fixed proportion of the employee’s current salary.
• Separate account for each employee => show the accumulated contributions.
• The account is portable.
• Not linked to the salary you'll be making when you retire.
• At retirement, receive whatever in your account in either a lump sum or a
stream of fixed annuity payments over time.
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Qualified Pension Plan

• An employer establishes such a retirement plan on behalf of and for

the benefit of the company’s employees. It is one tool that can help
employers attract and retain good employees.
• Employer's contributions to the plans are tax deductible
=> Reduction of corporate income tax.
• In contributory plan, it allows employees to defer a part of their
salaries to the plan, thus reducing their income tax liability
=> Reduction of personal taxable income
• Income on investments are tax free
=> Investment capital can build up more quickly.
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Supplemental Plans
• SUPPLEMENTAL PLANS: voluntary & enable employees to increase the
amount of funds being held for retirement and to enjoy tax benefits.
• Profit-sharing plans:
Employees of a firm are allowed to participate in the company’s earnings.
No specific levels of contribution or benefits by the employer.
• Thrift and saving plans:
The firm contributes an amount equal to a set proportion of the employee’s
contribution.
E.g.: Employer’s contribution = 50% of employee’s contribution.
No tax benefit for the employer.
• Salary reduction plans:
The employee has the option to divert part of his/her salary to a company-
sponsored, tax-shaltered saving account.
Tax must be paid eventually, but not until the employee starts drawing down the
account at retirement, presumably when he/she is in a lower tax bracket.
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Annuity – Basic concepts
• Annuity: an investment product created by life insurance companies that
provides a series of payments over time.
• Annuitant: person buying the annuity
• Accumulation period: the period over which premiums are paid toward
the purchase of an annuity.
• Distribution period: the period over which payments are made.
• Payments include:
Principal: the premiums paid during the accumulation period.
Interest: the amount earned on the contributed premiums between the time they've
paid and distributed.
Survivorship benefits: premiums and interests that have not bTeen returned to the
annuitant before death.
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Sources of annuities

Life insurance Banks Mutual funds Stock brokers

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Costs Age at
issue &
payments
begin

Gender Cost Distribution

method

Number of
lives
covered

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Costs (cont.)

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Classification of annuities
Annuities

Premium Time
Deposition of Definition of
Payment Payments
Proceeds Benefits
Method Begin

Annuity Pure life

Single Installment Intermediate Life annuity Fixed
certain annuity

Flexible Deferred Period certain Refund Variable

Fixed Installment

Cash

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Classification: Premium payment method
• Single premium annuity:
• An annuity contract purchased with a lump sum payment.
• Usually require a minimum investment.
• Attractive tax feature
• Can be financed with cash value in life insurance
• Installment premium annuity:
• An annuity contract purchased through periodic payments made over time.
• Installment structures:
• Equal installments
• Large initial payment + equal installments
• Often used to purchase deferred annuity.
• Savings are built up overtime free of taxes => a bigger retirement nest egg.
• Premiums are fixed based on mortality rate at the time of purchase.

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Classification: Time payments begin
• Immediate annuity: The • Deferred annuity: The benefit
annuitant begins receive monthly payments are deferred for a
benefits immediately. certain number of years.

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 Classification: Deposition of proceeds
• Life annuity with no refund (pure life):
• An annuitant receives a specified amount of income for life, regardless of the length
of the distribution period.
• The estate or family receives no refunds when the annuitant dies.
• The largest monthly payments of any of the distribution methods
• Guaranteed-minimum annuity (life annuity with refund):
• The benefits may extend to named beneficiaries.
• Sub-categories:
• Life annuity, period certain: a guaranteed monthly income for life with a minimum number of
years.
• Refund annuity: if the annuitant dies, the designated beneficiary receives monthly payments
(or lump-sum) until the total purchase price of the annuity has been refunded.
• Annuity certain:
• Specified monthly income for a stated number of years.
• No consideration of any life contingency.

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Classification: Definition of benefits
• Fixed-rate annuity:
• Also called “interest-earning annuities”
• Payments: original investment plus guaranteed interest.
• Low risk.
• Variable annuity:
• Payments: vary with the investment results. Nothing is guaranteed.
• Annuitants: have decision making power in selecting the investments.
• Structure: variable annuity during accumulation period and a fixed annuity for
the distribution period.

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