Assume the following (in addition to those assumptions above):

• Pat’s starting salary will be $51,000, starting January 2021.

• Contributions are made at the end of each year, so at the end of 2021 there are 39 years remaining to Pat’s retirement.

• Since you’re trying to help Pat decide right now, you can ignore the possibility of promotions and job changes in the future. Focus on the facts available right now.

Required:

Write a short note to Pat (one-half page at most) with your recommendation. Use time value of money techniques to quantify your answer – financially, how will the two plans differ in terms of Pat’s retirement. There is no “right” answer, your calculations and explanation to Pat, and the quality of your writing will determine your score. Please submit it through Connect. There’s room for creativity here, so long as you give Pat an answer and demonstrate why you think that’s the best answer.

Transcribed Image Text:

"I only get one shot at this?" Pat wondered aloud. Mrs. Montgomery, human resources manager at ApCo Service Company, has just explained that newly hired employees (like Pat) must choose between two retirement plan options. "Yes, I'm afraid so," she concedes. "But you do have a week to decide." (Actually, you only have until Thursday, September 24, at 3:00 p.m. to decide.) Mrs. Montgomery's explanation was that the two alternatives are (1) the company's defined benefit pension plan and (2) a defined contribution plan under which ApCo will contribute each year an amount equal to 8% of annual salary. The defined benefit plan will provide annual retirement benefits determined by the following formula: 1.5% x years of service x salary at retirement. "It's a good thing my closest friend studied pensions in the accounting program," Pat tells her. "Now let's see. You say it's reasonable to assume our salaries will rise about 3% a year, and the interest rate they used in their calculations is 6%? And, for someone my age, you say they assume l'll retire after 40 years and draw retirement pay for 20 years. I'll do some research and get back to you." Pat's research consists of calling you. "Help, what should I do? Take the defined benefit pension plan, or the defined contribution plan? Tell me which I should choose." You tell your friend, Pat, to calm down, you can help. Assume the following (in addition to those assumptions above): "I only get one shot at this?" Pat wondered aloud. Mrs. Montgomery, human resources manager at ApCo Service Company, has just explained that newly hired employees (like Pat) must choose between two retirement plan options. "Yes, I'm afraid so," she concedes. "But you do have a week to decide." (Actually, you only have until Thursday, September 24, at 3:00 p.m. to decide.) Mrs. Montgomery's explanation was that the two alternatives are (1) the company's defined benefit pension plan and (2) a defined contribution plan under which ApCo will contribute each year an amount equal to 8% of annual salary. The defined benefit plan will provide annual retirement benefits determined by the following formula: 1.5% x years of service x salary at retirement. "It's a good thing my closest friend studied pensions in the accounting program," Pat tells her. "Now let's see. You say it's reasonable to assume our salaries will rise about 3% a year, and the interest rate they used in their calculations is 6%? And, for someone my age, you say they assume l'll retire after 40 years and draw retirement pay for 20 years. I'll do some research and get back to you." Pat's research consists of calling you. "Help, what should I do? Take the defined benefit pension plan, or the defined contribution plan? Tell me which I should choose." You tell your friend, Pat, to calm down, you can help. Assume the following (in addition to those assumptions above):

Answer rating: 100% (QA)

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