ABC has two pension funds, a Defined Benefit (DB) one and a Defined Contribution (DC) one. New employees may choose between the two funds.
The DB fund provides a pension with an accrual rate of 2% of final salary. Members contribute 6% to the DB fund and the employer funds the rest of the cost.
The DC fund has the following characteristics:
employer contributions of 10% of salaries
member contributions of 6% of salaries.
of those contributions, 1% of salaries are used for expenses and the remainder is invested for retirement.
the investment portfolio is expected to earn CPI + 7% p.a.
At retirement, members use their accumulated fund to purchase an annuity using an annuity factor of 17.45
Joanna is 25 and has just joined ABC. She plans to work until 65 and she expects to earn salary increases of CPI + 3% p.a. over her working career.
Assume salaries are paid annually in arrear.
(i) Calculate the replacement ratio (RR) Joanna can expect to achieve in the DB fund if she survives to retirement.
(ii) Calculate the RR Joanna can expect to achieve in the DC fund if she survives to retirement.
(iii) What other factors should Joanna take into account before choosing which fund to join?