Pension payments in retirement
Personal Financial Adviser, Oran Hall
QUESTION: I want to thank you for taking the time to share information with the public on investment and retirement planning. I have been following your articles for the past month and find them very useful.
Your articles have piqued my interest and have left me with a few questions that I would like to ask you on retirement planning.
Question 1 - Why isn't pension enough savings for retirement?
Question 2 - Since pension contribution is maxed at 20 per cent of one's salary in Jamaica, does it mean that upon retirement, pension payments will consequently be 20 per cent of one's pre-retirement income?
Question 3 - Where can Jamaicans find trained investment professionals/advisers locally?
FINANCIAL ADVISER: Thank you for your kind words. There are many factors that determine the level of pension that a person receives during retirement. Among them are the type of pension arrangement, the years of pensionable service, investment performance of pension funds, and the level of pre-retirement income.
With respect to your first question, the maximum pension payable is 75 per cent of pre-retirement salary, which can be defined in several ways, as you will see later.
You will readily see that the lower income would give you less on which to live and you would likely find it challenging to continue living at the standard to which you have become accustomed.
It is quite common to purchase an annuity for the retiree with the available pension funds to facilitate the payment of a steady stream of income during retirement.
With today's lower interest rates and higher life expectancy, and, therefore, a longer period over which a pension would be paid, the prices of annuities are higher, thereby negatively affecting the periodic payments made to the pensioner.
Pensions are not always indexed to inflation, that is, they do not increase with inflaton. Therefore, what starts off as a reasonable pension tends to become inadequate due to the effects of higher prices over time.
It can be argued that it is reasonable to pay a level of pension that is lower than pre-retirement salary because of the expectations of lower expenses during retirement. For example, it is generally expected that persons would have paid off their loans by the time they retire and that travelling and other work-related expenses would have been eliminated or significantly reduced. In reality, some expenses such as health-related ones tend to increase, and many other expenses tend to carry over into retirement.
It is also useful to observe that some persons earn income outside of their main income source, which is usually salary from an employer. These extra streams of income are not factored into pension contributions or pension income.
Contribution vs Payout
With respect to your second question, the fact that pension contributions are, at most, 20 per cent of pre-retirement income does not mean that pension payments will be 20 per cent of pre-retirement income. The calculation of a pension is not very straightforward as it is affected by many different factors.
In the first place, the level of pension to the pensioner depends on the pension arrangement. The pension paid from a defined contribution plan is based on the level of contributions to the pension plan and the income earned thereon.
On the other hand, the pension from a defined benefit plan is based on a pre-determined formula, which depends on the years of pensionable service and the level of pensionable income.
The formula notwithstanding, investment performance is also of interest to sponsors of defined benefit plans as it can have a bearing on the level of benefits and the sponsor's level of contribution.
How salary is defined also has a strong bearing on the level of pension paid. For example, salary could mean final salary or average salary over the last three years or five years. Each of these would yield a different figure.
Another factor that impacts retirement income to the pensioner is annuity prices, which are influenced significantly by age and gender.
The form of pension selected also determines the level of pension to the retiree.
The pensioner may opt for a fixed amount for the remainder of life. This is the cheapest form, but it leaves no pension income for beneficiaries after the pensioner's death.
The pensioner may also opt for a guaranteed pension for a stated number of years or may select a joint annuity so that the spouse may receive a pension after the death of the pensioner. As the additions increase, the annuity becomes more costly and the monthly benefits get less.
With regard to your third question, most investment professionals/advisers who are required by the Financial Services Commission to have a set minimum level of education in specified subjects are employed by various financial and investment companies. There are not many independent professionals in the Jamaican market.
I suggest you contact the Financial Services Commission in respect of independent corporate and individual practitioners.
Oran A. Hall, a member of The Caribbean Financial Planning Association and principal author of 'The Handbook of Personal Financial Planning', offers personal financial planning advice and counsel. firstname.lastname@example.org