The value of a pension
Oran A. Hall, Contributor
A good friend of mine loves to give the reminder that, at the end of one's working life, pay stops and pension replaces pay. But this will not be true for many Jamaicans considering that fewer than one hundred thousand persons are members of registered pension plans and retirement schemes.
This does not include those persons, including employees of the State, who get a pension but do not contribute to a pension fund or retirement scheme.
A good quality pension contributes significantly to financial stability and security during the retirement years.
A pension is an insurance policy for providing financial coverage for old age.
We create our pension by transferring some of today's employment income to a pension fund or retirement scheme where it is stored and invested to be paid as pension during retirement.
Every company or organisation has an age at which all employees will retire under normal circumstances. This is called the normal retirement age. This is generally 65. In some cases, this age applies only to men as women retire at 60. There are other variations.
DB VERSUS DC PLANS
There are two types of pension plans - defined benefit (DB) and defined contribution (DC) plans.
Under the DB plan, an employee's monthly pension is calculated on the basis of a formula which includes years of pensionable service and the employee's salary. The risk of ensuring that there are adequate resources to pay the employee's pension rests on the employer.
If the pension fund has a deficit, it is the employer who provides the resources to close it. On the other hand, it is the employee who bears the risk in a defined contribution plan.
Under the Pensions (Superannuation Funds and Retirement Schemes) Act 2004, the maximum annual pension is 75 per cent of annual salary at the normal retirement age.
Each member can contribute a maximum of 10 per cent of taxable pay to a superannuation fund, which may be a DC scheme, also called a money purchase, or a DB plan.
The 10 per cent includes both basic and voluntary contributions. The employer also contributes to the fund.
An Approved Retirement Scheme is a DC plan which is open to persons who are not members of a superannuation fund and to the self-employed.
In this case, the pension is based on the value of all contributions and any income earned thereon.
The employee or self-employed person can contribute up to 20 per cent of taxable pay, which is the maximum aggregate level of contributions allowed. For employed persons, the employer does not have to contribute, though some do.
The higher the contribution rate, the better the pension.
As much as possible, it is advisable to pay not just the basic, or mandatory, contribution but to pay the voluntary contribution as well. You will not miss the extra sum deducted as people tend to make their budget on what they have.
Small amounts invested tax-free over an extended period can become quite significant. There is no tax on the portion of employment income that is contributed to the pension fund or retirement scheme or on the investment income earned thereon.
Based on the Pensions Act, the average working lifetime is 40 years. For those persons living to the normal retirement age, their average future lifetime is more than half of their working life.
By one calculation, it takes about 40 per cent more in contributions to a taxable plan than to a non-taxable plan to produce the same level of pension.
Regardless of the kind of plan, the longer the time over which contributions are made, the better the pension. Start early.
Create a good pension while you work. This applies to older persons but certainly to the young as well. And create and grow a supplementary fund, too, by saving and investing additional funds to support your pension.
Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of "The Handbook of Personal Financial Planning", offers free counsel and advice on personal financial email@example.com