ORIGIN OF PENSIONS FUNDS
Pensions were initially intended as extra compensation meant to entice people to enlist into the military. As early as 1636, before the colonies were united as the U.S., the Plymouth colony offered a pension for those who were disabled as a result of defending the colony from the Indians (Native Americans).1 During the Revolutionary War, the promise of extra compensation was solidified with the first pension law. Though the states were responsible for making payments, they fulfilled their obligation to only 3,000 disabled veterans.
In 1789, the U.S. federal government passed legislation assuming full responsibility for making the pension payments to disabled veterans. From then on, the federal government passed further legislation increasing benefits for veterans and their families as the country grew ever more prosperous. In 1818, benefits expanded to all veterans for life. Before that, pensions were only offered for a few years.
Then came the corporate pension in the U.S. was established by the American Express Company in 1875. Prior to that, most companies were small or family-run businesses. The plan applied to workers who had been with the company for 20 years of service, had reached age 60 and had been recommended for retirement by a manager and approved by a committee along with the board of directors.
As time went on, pensions were used to entice private sector workers in economic boom times. Pensions became the most popular during World War II. During this period, workers were signing up for the draft instead of signing up for jobs. At the same time, the National War Labor Board froze wages in order to prevent inflation from getting out of control. This caused a massive labor shortage because there were less workers available and no means of offering increased compensation except through fringe benefits like the defined benefit pension plan.
Overtime we have seen the evolution of retirement savings in different form with the Egyptian introducing a form of gratuity to its workers in the farm and Masonries in form of pennies after working for a period of time, which was being treated as gratuity during that period until the Second World War.
Currently we have seen the evolution of the form of retirement savings changed drastically and accommodative to the current modern society and good governance has come into play globally to make Pension a more critical path towards retirees after employment.
Topic 1. Introduction to retirement savings
What is the purpose of establishing a retirement scheme fund?
A retirement scheme fund is the accumulation of contributions and investment of such contributions to get income. The fundamental objectives include: –
- Benefits to members on leaving service.
- Benefits to members on attainment of retirement age.
- Deferred compensation.
- Stabilize financial wellbeing of retirees.
- Provide financial protection to members’ dependents on death in service.
- Provide disability benefits.
- Government wants to enhance welfare of society.
- Employer provides it for competitiveness.
Retirement Planning; what does it entail?
Retirement is one of the most important life events many of us will ever experience. From both a personal and financial perspective, realizing a comfortable retirement is an extensive process that takes sensible planning and years of persistence. Even once, it is reached; managing your retirement is an ongoing responsibility that lasts throughout your life.
The complexity and time required to build a successful retirement plan can make the whole process seem daunting. However, it can often be done with fewer headaches (and financial pain) than you might think – what it takes is some homework, an attainable savings and investment plan, and a long-term commitment.
Why Plan for Retirement?
This may seem like a trivial question, but you might be surprised to learn that the key components of retirement planning run contrary to popular belief about the best way to save for the future. Further, proper implementation of those key components is essential in guaranteeing a financially secure retirement. This involves looking at each possible source of retirement income.
- Uncertainty of social security and pension benefits – the challenges are; social security is expensive, DB scheme not performing, collapse of company under DC scheme
- Unforeseen medical expenses – Social Security benefits will never provide you with a financially adequate retirement. By definition, the program is intended to provide a basic safety net – a bare minimum standard of living for your old age.
Old age typically brings medical problems and increased healthcare expenses. Without your own nest egg, living out your retirement years in comfort while also covering your medical expenses may turn out to be a burden too large to bear – especially if your health (or that of your loved ones) starts to deteriorate
- Estate Planning – Without a well-planned retirement nest egg, you may be forced to liquidate your assets in order to cover your expenses during your retirement years. This could prevent you from leaving a financial legacy for your loved ones, or worse, cause you to become a financial burden on your family in your old age.
- The flexibility to deal with changes – As we know, life tends to throw us a curve ball every now and then. Unforeseen illnesses, the financial needs of your dependents and the uncertainty of Social Security and pension systems are but a few of the factors at play. A secure nest egg will do wonders to help you cope with the challenges of your life’s later years.
Retirement Planning How much will you need?
No.1 retirement question: “How much money does one need to retire?”
We look and good and bad?
First, the bad news: There really is no single number that would guarantee everyone an adequate retirement. It depends on many factors, including your desired standard of living, your expenses (including any medical costs) and your target retirement age.
Now for the good news: It’s definitely possible to determine a reasonable number for your own retirement needs. All it involves is answering a few questions and doing some number crunching. Provided you plan ahead and estimate on the conservative side, you should be able to accumulate a nest egg sufficient to last you through your retirement years.
There are several key tasks you need to complete before you can determine what size of nest egg you’ll need to fund your retirement. These include the following:
- Decide the age at which you want to retire.
- Decide the annual income you’ll need for your retirement years. It may be wise to estimate on the high end for this number. Generally speaking, it’s reasonable to assume you’ll need about 80% of your current annual salary in order to maintain your standard of living.
- Add the current market value of all your savings and investments.
- Determine a realistic annualized real rate of return(net of inflation) on your investments. Conservatively assume inflation will be 4% annually. A realistic rate of return would be 6% to 10%. Again, estimate on the low end to be on the safe side.
- If you have a company pension plan, obtain an estimate of its value from your plan provider.
- Estimate the value of your Social Security benefits.
NB; Note you have to factor in inflation (big word); a general increase in prices and fall in the purchasing value of money.
Consider the hypothetical case of Kanja, a 40-year-old man currently earning $45,000 after taxes. Let’s go through the key factors for John:
- Kanja wants to retire at age 65.
- Kanja will need $40,000 of annual retirement income – in today’s dollars (i.e., not adjusted for inflation).
- Kanja currently has $100,000 in savings and investments.
- Over 25 years of investment (age 40 to 65), Kanja should realistically earn a 6% annualized real rate of return on his investments, net of inflation.
- Kanja does not have a company pension plan.
Now, Kanja determined he would need $40,000 (in today’s dollars) annually to live during his retirement years. To the nearest $100, this works out to about $3,300 per month. Assuming John’s Social Security funds come through as estimated, we can subtract his estimated monthly benefits from his required monthly income amount.
This leaves him with $2,000 per month that he must fund on his own ($3,300 – $1,300 = $2,000), or $24,000 per year.
Nest Egg – sum of money saved for
Keep inflation in check?
You don’t need to worry about this too much for your retirement plan, but just keep inflation in mind when you determine how much you want to save for your nest egg every month.
Other Factors that come into play?
Even if your financial estimates are not fully realized – for instance, your investments earn lower-than-projected returns, Social Security benefits don’t come through, tax rates are higher than projected, etc. – there are other factors that can change the retirement picture dramatically.
WHERE WILL FUNDS COME FROM?
- Employment Income – As you progress through your working life, your annual employment income will probably be the largest source of incoming funds you receive – and the largest component of your contributions to your retirement fund.
- Social Security – Social Security benefits can provide a small portion of your retirement income
- Employer Sponsored Retirement Plan – the funds from your employer plan can help cover your living expenses during your retirement. However, most employer plans have rules regarding the age at which you can start receiving payments
- Current savings and Investments – If you already have a sizable investment portfolio, it may be sufficient to cover your retirement needs all by itself. If you have yet to begin saving for your retirement or are coming into the retirement planning game late, you will need to compensate for your lack of current savings with greater ongoing contributions.
- Other Sources of funds – You may have other sources that will be available to fund your retirement needs. Perhaps you will receive an inheritance from your parents before you reach retirement age or have assets, such as real estate, that you plan to sell before retiring.
CASE SAMPLE ON COMPETENCY SKILLS (structured assessment activity)
Come up with a projection Pension calculator of retirements saving for future
BUILDING A NEST EGG?
There is a myriad of investment accounts, savings plans and financial products you can use to build your retirement nest egg. Many countries have government-sanctioned retirement accounts that provide for tax-deferral while your savings are growing in the account, thus postponing taxation of your investment earnings until you withdraw your funds for retirement.
Choosing a nest Egg?
- Government Sponsored Vehicles – Most governments of developed countries provide a legal framework for individuals to build retirement savings with tax-saving advantages. Due to the advantages these investment accounts offer, there are usually limits regarding contribution amounts and age limits at which you will stop enjoying the benefits of those savings plans.
- 401 (K) – A401(k) plan is a voluntary investment account offered to employees by their company. The plan allows up to a certain percentage of your pre-tax employment income to be contributed to your 401(k) account. This means that you do not have to claim the portion of income you route to 401(k) as employment income for the year it is earned. As well, all investment gains you reap from the funds invested in your 401(k) are not taxable as long as they remain in the fund.
- Company pension plans – Many private businesses have shifted from offering defined-benefit pension plans to other forms of employer-sponsored plans, such as defined-contribution plans, but some still do offer defined-benefit plans to employees.
- Other Product – we have annuities, post-retirement medical schemes, Income Drawdown
IMPORTANCE OF SAVING
There are dozens of excuses that people use for not saving for retirement. And they all sound good. In fact, you probably have a few of your own. Rather than add fuel to the fire, in this article, we’ll give you four reasons why you should save for retirement.
Excuses Vs. Reasons
Excuses are just justification for not doing what we know we should be doing or should have done. Therefore, you should save for retirement because:
- You don’t want to rely on the welfare system to finance your retirement years.
2. You won’t to have to live with your children just because can’t afford to live on your own.
3. Saving in a tax-deferred account reduces your income taxes.
4. Saving in a tax-deferred account produces a compound effect on your return-on-investments.
- You don’t want to rely on the welfare system to finance your retirement years.
There’s nothing wrong with relying on the country’s welfare system for financial assistance if you have to. Many Kenyans have used it as a bridge to achieving theirfinancial independence. And, it is your right to do so, especially when you have spent all of your working life paying into the system. The issue is, do you really want to be in the position where that is your only choice during your retirement years? How would that affect your retirement lifestyle? With the limitations that you would face with such limited financial resources, you run the risk of barely being able to afford the basic necessities.
- You won’t to have to live with your children just because you can’t afford to live on your own.
If you have children, you probably wouldn’t mind spending as much time with them as you possibly can. But – for the most part – you probably also want that to be at your discretion. Having to live with your children because you don’t have the financial resources to live on your own isn’t how most people want to spend their retirement years – regardless of whether your children feel you are a welcomed responsibility or a burden they simply cannot afford.
Retirement as Replacement for salary
The rule of thumb you are referring to stems from “replacement ratios” — or the percentage of pre-retirement income you need to replace in retirement to maintain the standard of living you enjoyed during your career.
Many Employees during their working period will be asking themselves a very big question as they approach retirement
“How Much Income will they earn at retirement”
The answer to this will be very simple; you are looking at your income replacement ratio after retirement.
A Replacement Ratio is a person’s gross income after retirement, divided by his or her gross income before retirement. For example, assume someone earns 600,000 per year before retirement. The Income replacement ratio should be between 60% to 70% of the 600,000, which will be between 360,000 and 420,000 during retirement.
The Replacement Ratio is one of the useful tools that we can use to measure the adequacy of current retirement savings by looking at the member has projected pension at retirement expressed as a percentage of his or her projected salary at retirement.
Below are various factors used to determine the value of your pension benefit?
- The type of Fund you are invested in is a key factor:-
- A Defined Benefit Scheme is a formula based benefit using your final average salary over the last year and years of service.
- A Defined Contribution Scheme is an accumulation of contributions and growth into a retirement savings pool.
- For Defined Contribution funds, the following factors determine the end benefit:-
- Level of contributions to the fund,
- Returns earned on those contributions, and
- The period of the investment. The longer a member contributes, the larger the savings pool will be.
Most members will not receive a pension that matches their salary or standard of living on retirement.
Members do not necessarily need 100% of their salary as a pension when they retire, and are often able to retire comfortably with a Replacement Ratio of 70%. This is because after retirement, living expenses are usually lower and debts are usually paid off.
Should you aim to receive 75% of your final salary as a pension or do you only need 60% or should you aim for your full salary as pension? Your Replacement Ratio depends largely on the lifestyle you want to maintain once retired. It is clear that it will not be appropriate to apply the same Replacement Ratio for every member. An acceptable Replacement Ratio therefore depends on the member’s circumstances and expected lifestyle after retirement.
We have various factors that assist in attaining a positive Replacement ratio in retirement;
- start saving early,
- save at the correct contribution levels,
- ensure the investment portfolio is appropriate
- Do not cash in your retirement benefits when changing jobs (preserve the benefit)
This gives the member the best chance of having a comfortable and carefree retirement.
All fund members need to analyze their projected pension at retirement regularly. The perception, especially among younger employees, is that one can postpone saving towards retirement until a later age but this is not correct.
Importance of saving for retirement
Retirement is something that’s fairly easy to put off and worry about later, especially when you are young. After all, everything will sort itself out in the end, right?
Well – what if doesn’t? what’s your plan then?
That’s the problem with that strategy — often life won’t work out the way you planned. And if it doesn’t, you’ll put yourself and your family in a less than ideal situation. The best way to do that is plan for Retirement.
Chances are, you don’t plan to work until the day you die. You may have even envisioned your dream retirement, sipping cocktails on a beach, on a porch in a cozy mountain retreat, or off traveling the world. But it actually takes careful financial planning for these dreams to be realized.
There are four reasons why retirement planning is important, I will be discussing herein below:
- The Average Life Expectancy Continues to Rise
The first reason you need to kick-start your retirement planning is the simple fact that people are now, on average, living longer than ever before. A longer life means you’ll need more retirement funds saved to continue to live off of. With the average Kenyan lifespan creeping up toward 60 years old for men and 65 years for female, it’s easy to see that you will need a substantial sum to live comfortably in your retirement.
This is especially true because while the average life expectancy is now nearly 65 years, people often live even longer than that. If you’re lucky enough to find yourself in the above average bracket, you’ll need to stretch out your retirement savings further than you had planned. That means saving more and planning for longer. The earlier you begin, the better your chances are for having enough retirement funds to last your entire lifespan.
In short, don’t plan for an average life expectancy — plan for more!
- You can’t work Forever
You might be defiant and think you can work until the day you drop, and for some, that may be the dream, but the fact is you can’t perform your profession at a high level for your entire life. As you age, you’re going to slow down and certain tasks will become more difficult.
No matter how much you want to keep working for your entire life, it is no excuse to not save for retirement. Having that money handy prepares you in case you retire earlier than anticipated. Without a retirement fund to fall back on, you’ll be stuck in your “work forever” plan.
- Retirement is the best time to check off your bucket list
Retirement is the perfect opportunity to go after those places and experiences you’ve seen in photos or videos and always wanted for yourself. You can now collect these experiences and engage in the events you weren’t able to do during your career.
You know that big list of dream places to visit, and things to try and experience that you’ve probably been making your whole life? Chances are, during your working career and early life, there are often responsibilities at home that make accomplishing them quite difficult. Whether it’s your career, building a growing family, or other circumstances and life events, there are often things holding you back. No longer in retirement, as long as you planned accordingly, that is.
Having a good financial retirement plan eliminates stress and allows you to accomplish these goals. With a strong retirement fund, your money will free you up, rather than hinder you.
- Its unfair to depend on your family.
On the other side of the coin, imagine your future with your family if you didn’t see the value in planning for retirement. It would then become your children’s responsibility to take care of you. In your retirement, you shouldn’t be dependent on anyone, let alone your own family.
Having a firm plan in place will make sure you don’t become a financial burden on those you love the most. You want to be in a position to help a family member’s financial situation, not make things worse.
Ultimately You’ll put yourself in the best situation if you start planning for retirement early on. Accumulating the funds you need for a comfortable retirement may take decades, depending on your income, and you’ll want as large of a nest egg as possible when you are no longer bringing in a salary. By starting to invest in your retirement early on in your career, your funds will accumulate and grow over time, leaving you with a substantial enough fund to fulfill your retirement dreams.
A nest egg is a sum of money being saved so that it can be used in the future. Typically, when we use the term “nest egg,” we’re referring a retirement account. By putting money aside during your working years, and establishing a strong investment portfolio with that money, you’ll help ensure that you have enough income to support yourself financially once you’re no longer working.
Many retirees count on Social Security to help cover their living expenses. But helpful as those benefits tend to be, they’re generally not enough to sustain seniors without additional income. That’s why it’s critical to establish a nest egg during your working years — so you’ll have savings to withdraw from once you’re no longer actively generating an income.
The Importance of a Nest Egg
For many years, a common objective for individuals was to save a nest egg of at least $1 million in order to live comfortably in retirement. Reaching that sum would, in theory allow the individual to sustain themselves on their retirement investment income generated annually. Based on annual inflation, however, the ideal size of a nest egg continues to increase as the purchasing power of the dollar diminishes.
In addition to cash and securities, other assets that are expected to grow in value and generate a positive return on investment over time might make up part of a nest egg. Prized artwork and other rare collectibles may be held as assets to appreciate and later possibly sold to provide the hard currency for retirement. Real estate in a prime location that is likewise held in ownership with the expectation of the property value increasing could be part of a nest egg. Even if they do not develop the property themselves, a landowner might hold on to real estate anticipating its value will increase and that a buyer will offer them the return they seek. The proceeds from the sale could then go towards their retirement.
The role of Government in the pension industry in Kenya
The Kenyan Pension industry remains a significant growth area, which needs structural changes in management and governance in order to meet the ever-changing scheme member needs. These reforms are directly linked to the general economic growth of the country. The study asserts that the set 6% contribution is sufficient to meet the welfare conditions of Kenyans. This has been supported by majority of the stakeholders (scheme members, administrators and fund managers among others) however; good implementation strategies need to be put in place in order for the public to realize the good effects of the same.
Kenya being a British colony has adopted so much from the British system of saving. Among many includes the formation of the National Social Security Fund (NSSF), which is similar to the state pensions of the United Kingdom (UK). In addition, the setting up of occupational pension funds in Kenya is borrowed from the UK (Mghali, 2003). Ginneken (1998) Refers to social security as benefits that the society provides to individuals and households through public and collective measures to guarantee them a minimum standard of living and to protect them against low or declining living standards arising out of a number of basic risks and needs. Whereas pension benefits are only paid to an individual or his family based on that person’s employment record and prior contributions to the system, social security schemes incorporate welfare, of which financial assistance is extended by the state to persons who qualify on the basis of need. Social security is thus a social insurance program.
The Government has played a key role to ensure that the industry is well vast and regulated to cater for safer environment on pension savings both from the service providers to the members belong to various types of schemes in the Kenyan market.
The emergence of full-fledged reforms on introduction of Retirements Benefits Authority (RBA) in 1997 has rekindled the hope of older persons especially regulatory body has been keeping a close check on retirement programs in Kenya to ensure the pension industry operates with high levels of efficiency.
We have also seen the passage of several bills in amendment to the previous act in connection to the pension Industry so us to accommodate the new development changes in the industry for proper efficiency and governance of the pension industry in Kenya.
Why Employers are setting up pension scheme for its employees
Many employers contribute to their employees’ retirement accounts. When you choose not to contribute towards your retirement, you are quite literally saying “NO!” to money that the employer is freely giving to you.
Here is why you need to save now for retirement through your employer:
- You are young and the future is in your hands.
Seemingly, tiny contributions made at an early age will over the years multiply. “The power of compound interest”. Therefore, the sooner you start saving and investing, the earlier you take advantage of compound interest; making it easier to achieve that financial goal. For example with a pension saving in the Kenyan market if you are 20 years old and contribute 2,000 for 20 years, you will have 1,261,973 by the time you are 40 years old. If you decide to contribute the same amount but for 30years, you will have 3,087,072 by the time you retire at the age of 50, taking into play an average weighted return of 10% annually.
- You have a wider choice of investment options!
A longer time to invest means that you can take greater risks with the investment instruments that you select. This is because you have more time to bounce back for greater gains in case things head south.
Those who start late usually have little wiggle room and tend to stick with the generally safer and more restricted investment vehicles.
- You can have guarantees on the returns on your savings
A number of retirement plans give absolute guarantees on minimum rates of return. Therefore, when it comes down to the money, you can never, on retirement, have a total fund that is less than your total contributions.
- You are still the master of your budget
The babies are not yet here, the mortgages have not yet come through and your monthly shopping budget very possibly has only you as the consumer.
It is easier to quickly make retirement savings a permanent item on your budget without having to struggle with so many other expenses.
An early budget provision for retirement savings will quite literally get you off the “not enough therefore no savings” mind set
- You get “free” money from your employer
Many employers contribute to their employees’ retirement accounts. When you choose not to contribute towards your retirement, you are quite literally saying “NO!” to money that the employer is freely giving to you.
- You will pay less tax
The Government, which most of us feel takes too much from us, actually gives tax breaks to all who contribute to retirement schemes. You can get as high as 20, 000 as a relief before your salary is assessed for tax! For example, an individual earning 50, 000 and making a monthly contribution of 5000 will be taxed on 45,000.
- You will be free to do as you please, for the rest of your life
Many of us aspire to spend the years after retirement travelling the world or living in that Villa. No one dreams of a “broke” future.
There are other factors that enable the employer purposely have the retirement savings for its employees is as below;
- To encourage a saving culture
- The pension savings act as a retention tool for employees
- It acts as a reward for long service in employment
- Improves competitiveness within the Kenyan market
Other instruments of saving in the market besides pension
Savings refer to any disposable income not spent on consumption and is aimed at securing future needs, both short and long-term. Rather than save what is left of your income after deducting expenses, it is more prudent to first deduct a set savings amount from your income and only spend what is left after saving i.e. “Pay yourself first. “People save for various reasons:
- a) Emergencies: These could be any number of things: an emergency expense for the house, medical expenses, or sudden unemployment and loss of income
- b) Education: With expensive education for children, it is important to save and plan ahead
- c) Retirement: As you retire someday, savings will have to take the place of regular income
- d) Social Security: Social Security was never intended to be the primary source of income and is only a supplement.
Positive savings can help one achieve both current and future financial goals. At the very minimum, the basic rule of thumb is to save at least 6 months of living expenses to cater for any emergency.
Five Key things to note while saving and investing:
- Make a budget: A budget is an estimate of the incomes and expenses for a set period. A budget gives you control over your money, saves the stress of suddenly having to adjust due to reduced income, and allows you to gauge how much you can save each week or month. Additionally, a budget aids in deciding which short-term expenditure to sacrifice in order to enjoy long-term benefits like a comfortable retirement.
- Pay yourself first: Saving should not be viewed as what is left after current needs and wants have been satisfied. “Pay yourself first” is an effective savings strategy that entails first saving a portion of the money earned, e.g. 20% of net income, before spending on consumption. To successfully practice the “pay yourself first” strategy, one should set personal goals as you can focus on what you will be able to do once you’ve reached your goal rather than what you are saving;
- Do not take unnecessary risk: Understand all the inherent risks in savings products. Ideally, savings should be invested in the highest returning assets, on a risk-adjusted basis;
- Allow time to work for you: The concept of time value of money is important. The more time an individual has to save and invest, the more they end up with in the long run since money invested is compounded. Compounding occurs when the interest you earn is added to the balance in your account, creating a larger base upon which future contributions and interest can grow. So it can be a powerful force, especially over long periods of time. It’s probably why Albert Einstein once said, “compounding is the most powerful force in the universe”;
- Diversify: Never put all your eggs in one basket. Spread your money between different kinds of savings products to help reduce the overall risk, as no investment product performs well all the time.
Where Can Money Be Saved?
In Kenya, there are a range of saving options and products, which can be broadly categorized into:
Deposit Accounts: These are accounts held by banks and earn interest on the amounts deposited. They can either be savings or fixed deposit accounts. The risk profile is low since the returns are guaranteed. However, a downside exists in that your money’s buying power is eroded over time if inflation is higher than the interest rates paid, which is the typical situation with most deposits.
Financial Markets Instruments: This refers to investments in shares of listed companies in fixed income securities such as Treasury bills and bonds. Stocks are suitable for long-term investors due to the volatile nature of the market and since the returns are not guaranteed, stocks have a higher risk profile. Fixed income securities are suitable for short to medium-term investors, and are not as volatile as stocks. Fixed income securities offer issuer-guaranteed returns hence have a lower risk profile.
Collective Investment Schemes (Pooled funds): These are schemes such as unit trusts and mutual funds, made up of a pool of funds collected from many investors for the purpose of investing in stocks, bonds, real estate and private equity, among others.
Structured / Private Solutions: These are usually saving solutions such as Structured Notes and Cash Management Solution (“CMS”) which are packaged by investment professionals, typically tailor made for the investor to enable investors access pockets of returns in the market that are not readily accessible through traditional investment avenues such as stocks, bonds and bank deposits. Structured products are relatively more complex, but they also offer higher returns relative to traditional products.
Age Grouping and Retirement Planning.
Below is an analysis that can help you categorize the three groups in employment based on retirement’s savings.
Young Adults (18-39)
- This is an employment stage where the individuals have a very high disposal income and more savings on retirement is encouraged at all cost given the age group is perceived to be a risk taking on any void investments.
- They need to consider building an emergency fund this is just to cater for any unforeseen events in future and more likely when they leave employment they are at liberty to use the emergency funds instead of cashing out the pension funds.
- They need to maximize on the compounding interest given the longertivity of savings is pegged on power of the compounding interest.
Middle aged Adults (40-54)
- This is an age bracket that has reached an actualization and most of the individuals have diversified investments cutting across education to tangible assets.
- This age group cannot ignore the aspect of adjusting their financial investment in form of balanced portfolio and more so to have a game plan on how any liability should be cleared before hitting the retirement age.
Age 55 and Older
- This age group marks a new beginning in life towards retirement and majority of the members herein will be cashing out their benefits they have been saving for their entire period of being employed.
Pension scheme – types of pension schemes in Kenya
- When you look at the Kenyan Pension Industry we have different types of pension scheme that exist and the table below summarizes in a simpler way; however, we will now be discussing them in details
- Given the importance of retirement benefit schemes, it is vital to know how they work. Kenya has different types of retirement schemes that one can enroll in.
- Besides the statutory scheme, the National Social Security Fund (NSSF), retirement schemes can be classified as either individual or occupational schemes.
- The basic difference between these two categories is the initiator of the scheme. An Individual pension plan is usually set up by an individual to make contributions on his/her own behalf towards saving for retirement, while an occupational scheme is set up by an employer who makes contributions on behalf of their employees for the provision of retirement benefits. In most instances, the employee also makes contributions (together with the employer) in an occupational scheme.
- It is not mandatory for an employer to provide a retirement scheme to its employees. However, if an employer does establish a retirement scheme, they are obligated to comply with the retirement benefits legislation and the established rules of the retirement scheme.
- A multi-employer umbrella scheme is a variation of the typical stand-alone occupational scheme.
- stand-alone occupational scheme consists of a sole employer who initiates the scheme — only eligible employees of the employer would be able to participate in the scheme.
- They are more popular with medium to large sized organizations who can sustain the operational costs of running a scheme.
- Umbrella occupational schemes allow multiple, unrelated employers to participate in a single pension scheme. They are popular among all types of organizations, including medium to large organizations due to their cost-effective and “hands free” nature.
- When an employer joins an umbrella scheme, they are joining a pre-existing scheme that has already been registered and is operational.
- In addition, the time and resource requirements for the employer are greatly reduced through an umbrella scheme, which effectively works like a professionally outsourced pension solution. This has proven very attractive to employers around the globe.
- Retirement schemes can be further classified depending on:
- their registration as either a Provident Fund or a Pension Scheme;
- the investment plan of the scheme (guaranteed and segregated funds); and
- the design of the scheme (Defined Benefit and Defined Contribution schemes).
Provident Funds vs. Pension Schemes
Provident fund means a scheme for the payment of lump sums and other similar benefits to employees when they leave employment or to the dependants of employees on the death of those employees.
In the case of a pension fund at the point of retiring a proportion of the retirement fund is commuted as lump sum with the remainder paid out as periodical payments. The commuted amount will be equal to no more than one quarter of the retirement benefits in a scheme where members do not make any contributions and not more than one third of the retirement benefits in a scheme where members make contributions.
There are other classifications based on a number of factors such as the manner of investment and whether established by employers or by independent bodies for individual savers. Such schemes are:
- Segregated Fund and Guaranteed Fund
- Occupational Scheme and Individual Scheme
See below Similarities difference in a table format;
|Provident Fund||Pension Fund|
|If a member leaves the organization before the age of 50 years the member is eligible to access his full employees benefits and 50% employer benefits and the remaining 50% employer locked benefits remains to be accessed at early retirement (50 years of age)||If a member leaves the organization before the age of 50 years the member is eligible to access his full employees benefits and 50% employer benefits and the remaining 50% employer locked benefits remains to be accessed at early retirement (50 years of age) subject to the pension rules under the RBA Act|
|When a member leaves on retirement grounds he/she is eligible to access his/her full employee and full employer benefits in lump sum.||On retirement the member is eligible to access only 1/3 of his cumulative benefits and 2/3 of the remaining benefits goes towards an annuity purchase or income drawdown pegged on the trivial pension. However, any additional voluntary contribution is not subjected to any annuity purchase as the funds is paid to the member in full.|
Guaranteed Funds vs. Segregated Funds
The Trustees of a retirement scheme have to develop an investment plan and strategy in order to generate a return on the members’ contributions (while managing risks at an acceptable level).
Guaranteed funds are offered by insurance companies where the members’ contributions are invested as a pool of funds.
The guaranteed fund is comparable to an insurance policy the contributions are more like a premium, with the insurance company guaranteeing a pay-out of a return of contributions and a minimum (guaranteed) level of interest.
In segregated funds, members’ contributions are invested directly by the Trustees via an appointed Fund Manager.
The Trustees establish an appropriate investment strategy which is then implemented by the Fund Manager. The scheme directly holds the investments and the returns are fully accrued to the scheme for the benefit of members.
Defined Contribution and Defined Benefit
A defined contribution (DC) scheme is a scheme in which member’ and employer’ contributions are fixed either as a percentage of pensionable earnings or as a shilling amount, and a member’s retirement benefits has a value equal to those contributions, net of expenses including premiums paid for insurance of death or disability risks, accumulated in an individual account with investment return and any surpluses or deficits as determined by the trustees of the scheme.
DC Schemes are arrangements where the retirement benefit is not known or defined in advance. Rather the level of retirement income receivable on pay-out date is related to the:
- level of contributions made over the accumulation period;
- the charges deducted by the product provider;
- the investment returns of the fund during the accumulation phase;
- the annuity rates at retirement.
A defined benefit (DB) Scheme is an arrangement where the benefits, which is ordinarily determined by the scheme rules, are defined in advance. Benefits are often related to the final salary and/or years of service of the employee. The main risk for beneficiaries is the solvency of the employer so as to be in a position to meet the promised benefits.
|EFINED BENEFIT SCHEMES||DEFINED CONTRIBUTION SCHEMES|
Risk of investment performance
|Certainty of benefits (easy to measure benefits in terms of adequacy and better for retirement planning)||Fixed costs||Fixed costs|
|Potential increase in cost (issue of sustainability)||Solvency of employer||No risk of investment performance||Risk of investment performance|
|Not very portable (hinders portability)||Uncertainty of retirement benefits|
|Portable and transparent|
Hybrid Schemes seek to combine features of DB and DC schemes in some way and can take a variety of forms. For purposes of categorization, hybrid schemes are DB schemes because of the promises they make to members.
Gratuity is a monetary gift from an employer to an employee especially for services rendered. The Employment Act provides for its definition and also for instances when it should be given.
Gratuity is a lump sum amount that an employer pays an employee if he or she retires or resigns from employment. An employee does not contribute any portion of her salary towards this amount. Gratuity is only paid out at the time of retirement or resignation, and in the event of death or being rendered disabled because of an accident or illness.
However, it is important to note that gratuity is given at the discretion of the employer, especially in cases where the employer has registered with a pension scheme and is contributing on behalf of the employees or the employer pays out service pay at the end of the contract.
Your employer pays out gratuity at the completion of a contract. There is nothing wrong with this. The employer is not in breach of the Employment Act because the employer expects the employee to perform work, which takes time to complete, and if the employee leaves midway then it means the employer has to employ someone else to complete the job. If the employer is to do this, it means the organization will lose out every time an employee leaves without completing the project.
Your kind of work seems to be project oriented, meaning the contract period is equal to the completion of the project. As such, your employer is correctly concerned with the completion of the contract and in some such projects, probably gratuity is to be paid out at the completion of the contract and does not factor in payment to an employee leaving midway.
Service pay on the other hand is similar to gratuity save that it is paid out at the end of employment while gratuity can be paid at the end of every year or at any time, if the employer so wishes.
An employee cannot get both service pay and gratuity and the employer has discretion to pay either of the two to the employee. In fact, Section 35 is clear on payment of gratuity and service pay and from the reading you can only get one of the two.
The Scheme is a contributory retirement scheme for participating employers and its employees. The scheme allows for centralization of duties, thereby reducing the need for employers to become involved in complex governance, trusteeship, investment, custody and administration issues of the scheme. The scheme is registered and regulated under the Retirement Benefits Act and the Income Tax Act.
Main purpose of the scheme is to provide a lump sum accumulated retirement benefits to the member/staff or nominated beneficiary in the unfortunate event of death of the member/staff.
All employees above 18 years old can join the scheme on completion of necessary application and nomination of beneficiary form.
The scheme is funded through;
- Employee Contribution
• Employer Contributions
• Transfers in (From previous employer(s)
• Investment returns
What are the benefits under Umbrella Schemes;
Withdrawals Benefits: On exit from current employment before attainment of 50 Years (early retirement age), the member is eligible to access 100% of accumulated employee benefit (Contributions + Interest) and 50% of employer benefit
Ill- Health Retirement Benefits: On exit from current employment due to illness/accident, the member is eligible to access total accumulated benefits (100% of both employee and employer benefits)
Immigration Benefits: On immigration from Kenya to another country, the member is eligible to access total accumulated benefits (100% of both employee and employer benefits
Retirement Benefits: On attainment of early retirement age (50 years), the member is eligible to access total accumulated benefits (100% of both employee and employer benefits)
Death Benefits: On the unfortunate event of death of the member/staff, nominated beneficiaries will be paid the total accumulated benefits (100% of both employee and employer benefits).
What are the tax benefits of the scheme;
Tax benefits on contributions: Up to Ksh 20,000 per month or Ksh 240,000 per annum of the members’ contribution into the scheme is not taxed at source/Payroll (tax deductible)
Tax benefits on Lumpsum Pay-outs: Upto ksh 60,000 per annum to a maximum of 10 years (Ksh 600,000) of the members’ accumulated benefit enjoys a tax relief based on years of service
Tax benefits on Pension Payments:
• Upto Ksh 300,000 per annum (Ksh 25,000 per Month) of the pension payment (Regular payment at retirement) is tax free
- Pension payments for members at age 65 and above is not taxed
INDIVIDUAL PENSION PLANS
is a retirement benefit arrangement designed on a defined contributory basis where by the growth of the benefit is made up of the amounts contributed and the interest accrued. The main objective of this scheme is to help individuals save for their retirement.
It caters for both informal and formal sector.
JOINING AND CONTRIBUTING TOWARDS A PENSION SCHEME
Setting up an occupational scheme need to know?
To begin with, the sponsor (employer) should resolve to start the retirement benefits scheme. In the case of a limited company, a board resolution is required. It is important that the employer originates the idea or at least buys the idea from the employees because of the financial obligations on the employer.
The second step is actuarial review, in which the general financial potential of the scheme is looked into. Schemes differ widely in nature and design. On one hand, an employer has the option of starting a pension scheme (which will pay monthly pensions or both monthly pensions and lump sum benefits upon retirement), or a provident fund (which pays lump sum benefits at retirement). With regard to design, an employer may start a defined benefits scheme (whose benefits are pegged on the years of service within a firm and the salary at retirement) or a defined contribution scheme (whose benefits is the sum of the employee’s contributions, employer’s contributions and investment income). It is, therefore, important that the scheme’s financial viability, contribution rates, nature and design be endorsed by an actuarial review carried out by a qualified actuary. The purpose of the actuarial investigation is to advise on the design and level of contributions that will achieve and sustain the required level of scheme solvency and ability to meet its future obligations.
TRUST DEED AND RULES
For adequate protection of the sponsor and members, the Retirement Benefits Act requires that schemes should be established by an irrevocable trust, and that the scheme documents be professionally prepared. A scheme will therefore be a ‘trust’ which can be defined as ‘an equitable obligation, binding a person (a trustee) to deal with property over which he has control (the trust property) for the benefit of persons (beneficiaries) of whom he may himself be one’. The scheme must therefore be created through the trust deed and rules. It is important to note that this document must be created within the provisions of the Retirement Benefits Act. The trust deed and rules is the document that created the trust and can be considered to be the constitution of the scheme. It is necessary to obtain professional advice on its preparation as it is an extremely important document.
It contains rules and operational details of the scheme and everything that a member needs to know about the scheme. If possible, this document should be summarized into a small booklet and distributed to members at the inception of the scheme.
APPOINTMENT OF TRUSTEES
After the preparation of the trust deed and therefore the establishment of the right nature and design of the scheme, the sponsor (employer) can then appoint trustees, one-third of whom must be nominated by the members in a defined benefit scheme. In a contribution scheme, half of them must be member-nominated. In the event that the employer does not want to appoint member trustees, he can appoint a corporate trustee (a body corporate) to run scheme affairs. Trustees are classes of persons appointed under an irrevocable trust to hold the scheme fund in trust for the benefit of members. The regulations provide that there should be at least 3 trustees (unless a corporate trustee is appointed). On the acceptance of the trust, the trustees have the following duties:
- A fundamental duty to administer the scheme in line with the trust deed and rules, which must be within the provisions of the Retirement Benefits Act.
- To keep proper books of accounts and allow the beneficiary and the sponsor to inspect them. They must also, on demand, give the beneficiary information and explanations as to the investments and dealings with the trust property.
- To liaise with service providers who are important players in the running of the scheme.
- To assume the duties of a trustee for as long as the period of the trusteeship. The law does not distinguish between active and passive trustees, and a trustee is fully liable to the beneficiaries for any loss that occurs even where the management has been delegated to a third party.
- To be bound by the decisions of the trust. Unless stated otherwise in the trust deed, all decisions of the trustees must be made by all of them. If the rules provide for a majority decision, then that decision binds the minority.
- To be jointly and severally liable for the decisions of the Trust. An aggrieved party may elect to sue one, some, or all of the trustees for redress.
REGISTRATION OF SCHEMES WITH THE AUTHORITY
Registration of schemes is mandatory and free for schemes. It needs to be noted that it is an offence to operate a scheme without registration. This, on conviction, may attract a maximum fine of Kshs. 500,000, imprisonment for a term of two years, or both. The Authority issues a certificate and keeps a register of all the registered schemes. Application forms for registration are available at RBA offices. These forms can also be downloaded from the RBA website at www.rba.go.ke.
The following attachments must accompany the form for registration of a new scheme:
- Trust deed and rules;
- Fund management agreement;
- Custody agreement;
- Actuarial certification (defied benefit schemes only); and, (
- Administration agreement. The Authority shall consider the application and notify the applicant in writing whether or not the scheme is eligible for registration. If a scheme satisfies all the requirements for registration, the Authority will forward to the scheme a certificate of registration.
COMMENCEMENT OF CONTRIBUTION AND APPOINTMENT OF SERVICE PROVIDERS
Upon registration, the trustees should appoint service providers while the sponsor should commence remitting both the employer’s and the employee’s contributions. The Retirement Benefits Act specifies various key parties who are required in the establishment and operation of a retirement benefits scheme. The principal parties are members, sponsors and trustees. However, there are also other important but secondary parties in this regard. These include managers and custodians. Finally, other professionals will often be required to prepare statutory reports and documents for schemes. The most notable categories include administrators, actuaries, legal advisors and auditors.
THE FUND MANAGER
The manager advises the trustees on available investment vehicles and expected risk and returns for each. The manager makes tactical asset allocation decisions based on the strategic asset allocation contained in the investment policy and RBA guidelines. The manager also undertakes research at company, sector and country levels, manages the portfolio so as to ensure liquidity and thus ability to meet the scheme’s needs, and provides accurate and timely periodic reports to the trustees and the Authority on scheme holdings and transactions. The general obligations of the manager include:
- Submitting quarterly investment reports;
- Sitting in attendance in board of trustees’ meetings convened to discuss an agenda involving investment of scheme funds;
- Issuing instructions on behalf of trustees to custodians to effect payments;
- Keeping or causing to be kept records and statements of investment transactions; and,
- Whistle-blowing, including, with regard to contributions remittance outstanding for more than 30 days.
The custodian must be a corporate body – almost always a bank – and is mandated to:
- Hold all the assets of the scheme including cash, securities, title documents and deeds;
- Settle all transactions in accordance with the instructions received from the manager;
- Receive and record all dividend, interest and other income due to the scheme and credit them to the scheme; and,
- Provide accurate and timely periodic reports to the trustees and the Authority on holdings and transactions. NB: The regulations provide that custodians should be registered by the Authority.
The administrator must be a corporate body or a natural person, and is mandated to:
- Carry out daily administration of the affairs of the scheme in accordance with the provision of the Act, scheme trust deed and rules, and keep scheme records;
- Co-ordinate meetings, submission of regulatory documents, facilitation of entry into and exit from the scheme, prepare scheme budgets, training of trustees, members, and sponsors; and,
- Provide data to service providers, give statements and computation of benefits, and conduct whistle-blowing as necessary.
NB: The regulations provide that administrators be registered by the Authority.
OTHER SERVICE PROVIDERS
Schemes may from time to time make use of other relevant professionals whose services are not regulated by the Authority. These include lawyers, actuaries and auditors. The administrator is mandated with the responsibility of handling all administrative affairs of a retirement benefits scheme (including application); ensuring that the scheme is run in accordance with the trust deed and rules; and, ensuring that the scheme is run within the Law. This role may be performed in-house by staff of the sponsor, by trustees or by contracted professionals with proven competence and capacity to perform the role. The actuaries play an advisory role as to the set-up of the scheme fund and conduct periodic reviews on funding adequacy of the scheme in relation to its benefits liabilities. Schemes should also enlist the services of legal advisors during the setting up of the trust deed and the rules of the scheme. Finally, auditors should periodically review the financial records of the scheme.
TAXATION AND REGULATION OF PENSION SCHEME
Saving in a registered retirement benefits scheme is one sure way of keeping your savings safe from the tax man. Contributions to a retirement benefits scheme aretax exempt as per the set limits (Kshs. 20,000/- per month or 30% of salary, whichever is less). The return earned on the investment is also tax exempt.
The Kenya Revenue Authority currently allows a tax relief up to a maximum of Kshs. 240,000 per annum or Kshs. 20,000/- per month for amounts contributed to a registered scheme. At withdrawal or retirement, you are also entitled to receive tax free lump sum payment from the fund of Kshs. 60,000/- for every year of membership in the scheme up to a maximum of Kshs. 600,000/-. The tax on the excess amount is then calculated as per the tax.
You can refer to the income tax act CAP 470;
The tax benefits that members do enjoy being in a pension scheme are as follows
- Tax- Free Contributions – contributions by both employee and employer to registered schemes are tax deductible subject to the below limits;
- In respect of the employees’ contributions, it is lower of 30% of pensionable income or the first 240,000/= per annum
- In respect of the employers’ contributions, it is 30% of the aggregate of pensionable income of the members or 240,000/= per annum, times the number of members whichever is less reduced by the employees’ deductible contributions.
- Tax Free Investment Growth – The investments income earned by the registered funds is also tax exempted in its entirely
- Tax Free Benefits – up to 600,000/= lump sum, is tax exempted or 60,000/= for every year of pensionable service, for annuity up to 300,000/= pension per annum or 25,000/= per month is also tax exempt.
TAXATION OF BENEFITS BANDS
- For those who terminate their membership in the scheme before the expiry of fifteen years, the tax free amount is Kshs. 60,000 for every year of membership up to a maximum of Kshs 600,000.
- The amount above the tax free is taxed at the following graduating bands:
- First Kshs. 147,580 at 10%
- Next Kshs. 139,043 at 15%
- Next Kshs. 139,043 at 20%
- Next Kshs. 139,043 at 25%
- Amounts above Kshs 492,610.76 at 30%
- Monthly pension income that is tax exempted is Kshs 25,000 per month, this applies to the annuitants and the tax for over 25,000/= is calculated in the payee bracket from the first 33,000/= taxed at 10% gradually on the band.
- However, when a member clocks 65 years of age no tax is applicable to the member.
- The current preferential tax treatment for members who leave a retirement benefit scheme after 15 years of service or those who retire after the age of 50 years or those who retire at any time on grounds of ill health is such that the first Kshs. 60,000.00 for every year of membership up to a maximum of Kshs 600,000 of lump sum payment is tax free. Any amount above the tax free amounts is taxed at wider bands of Kshs. 400,000 as follows:
- First Kshs. 400,000 at 10%
- Next Kshs. 400,000 at 15%
- Next Kshs. 400,000 at 20%
- Next Kshs. 400,000 at 25%
- Amount above Kshs 1,600,000 at 30%
- It’s Important also to note that special grounds that will warrant retirement in this case Ill Health, the member tax band will shift to the above wider bracket.
The Learners should be able to compute pension benefits before and after retirement for members leaving the scheme (Case study to be given by the trainer).
RETIREMENT OF BENEFITS
Members are allowed to access their benefits on the below grounds
- Emigration grounds
- Ill Health
Option available to access pension benefits
- Refund of Contributions
If a member leaves Service for any reason other than death or retirement, he shall become entitled to a lump sum benefit payable (100% Employees contributions and 50% Employer’s portion plus Investment Income) within 30 days from the date of ceasing membership.
- Preserved Benefits
The Employer’s portion shall be preserved in the Scheme and payment deferred until you attain the Normal Retirement Date, UNLESS the member:
(i) retires on grounds of ill-health or infirmity of body or mind; or
(ii) leaves the. country permanently; or
- has attained age 50 and above
- Transfer of Benefits
Instead of receiving the benefit entirely as a lump sum, the MEMBER may transfer part or all of the benefit to an:
– APPROVED PENSION SCHEME / PROVIDENT FUND; or
– REGISTERED INDIVIDUAL RETIREMENT BENEFIT PLAN chosen by him
The RBA regulations provides for a maximum period of 30 days within which members benefits must be paid
- On leaving service, it is important to notify Employer of your preferred treatment of benefits in writing
- Further, it is good to note that benefits payment process may involve parties which include;
- Administrator: Does benefits computations upon leaving the scheme and once approved the payment is effected to the member account.
- The member has to fill the withdrawal form and attach a copy of ID and KRA Pin
ANNUITY AND INCOME DRAWDOWN
Is a contract with an insurance company of your choice whereby you make a lump-sum payment (either 100% or 2/3 of the total benefit) and in return you receive a regular stream of payments (annuity) for life.
- Guarantee period – 0 years, 5 years, 10 years and 20 years – the higher the guarantee the lower the Monthly Income
- Single and joint life – types of Annuity
The Income Drawdown, as an alternative to the traditional annuity, is a variable annuity that allows a member to receive an income on a regular basis from their pension fund while keeping the balance invested in a guaranteed fund.
- Must be 10 years locked down
- The member can draw down on a regular basis but with a cap of 15% Per Annum
- Payments can be done on timing payments
PRIVATE PENSION ARRANGEMENTS – TYPES AND DESIGNS
- Schemes established through an irrevocable Trust
- A Trust Deed and Rules is developed to legally bind all the parties involved
- Trustees are appointed to hold the trust assets in trust on-behalf of scheme beneficiaries
- Registration with RBA and KRA for Tax Exemption
- Trustees serve a maximum renewable term of three years
- Board certification – Trustee Development Program Kenya
- Trustees required to meet quarterly with the service providers
WHY ESTABLISH A RETIREMENT SCHEME AS A TRUST
- Tax relief
CREATION OF A TRUST
- Property is held by one or more persons known as “Trustees”, for the benefit of others, who are known as “Beneficiaries” for the purposes specified by the “Trust” instrument
- Trust Deed between the sponsoring Employer and Trustees
- Supplemental or amending deeds
- Rules – Structure of Scheme
- Persons or classes of persons given benefit by the Trust document
Who is a trustee – A trustee is a person or firm that holds and administers property or assets for the benefit of a third party. A trustee may be appointed for a wide variety of purposes, such as in the case of bankruptcy, for a charity, for a trust fund, or for certain types of retirement plans or pensions.
A good Trustee needs;
– Common sense
– A knowledge of his Duties, Discretions
LAW RELATING TO TRUSTS
- The law relating to trusts is made up of:
Retirement Benefits Act 1997 and Retirement Benefits Regulations 2000 (as amended)
– Income Tax Act Cap 470 and Income Tax (Retirement Benefits) Rules
– Trustee Act
– NSSF Act
– Case law
TYPES OF TRUSTEES
- Trustees may be
- a number of individuals appointed by the employer, some of whom may also be elected by the members
- independent individuals or a professional trustee company, unrelated to the employer
- a corporate trustee established by the employer
- a custodian trustee
- Or any combination of the above
WHAT WILL A WARRANT A TRUSTEE TO BE DISQUALIFIED?
- Those sentenced to imprisonment for 6 or more months
- Bankrupt individuals
- Those previously involved in the management or administration of a scheme which was deregistered for any failure on the part of the management or the administration thereof
- Those disqualified under any other written law or whose appointment would be detrimental to the scheme.
COMPOSITION OF A BOARD OF TRUSTEES
Appointment of Trustees (RBA)
- Minimum of four trustee meetings Per Annum
- No more than four months between meetings
- Three-year term of office Maximum two terms to serve
- Need clear nomination/election process
- Chairperson elected by Trustees from amongst their number
- Trust Secretary
- Relationship between Trustees and Employer
- Independence of Trustee’s role
- Potential conflicts of interests
- Protection of trustees against victimization and discrimination
- Per Legal Notice 99 and 101 of 2016
Duties, Powers, Responsibilities –
What’s the Difference?
- Duty : A task which a person is bound to perform for moral or personal reason
- Power : The authority to do something
- Responsibility : A thing for which a person is accountable
- Discretion : The power to make a choice
CLEAR DUTIES OF A TRUSTEE;
- To act in accordance with Trust Deed and Rules
- To act in the best interests of their beneficiaries
- To act with reasonable care
- To act impartially amongst various classes of beneficiaries
- To act gratuitously
- To act jointly
- To ignore their own interests when these conflict with their duties as Trustees
- To familiarize themselves with the terms of their Trust
- To manage the scheme effectively and efficiently
- To disclose anything which may lead you to exercise discretionary powers unfairly
- To pay the right amount of benefits to the correct recipient
- To collect all money due to the scheme
- To invest the Trust Assets
- To prepare accounts
- To obtain expert advice in areas where they are not themselves expert
- Be aware of relevant legislation and comply with it
TRUSTEES POWERS AND DUTIES
- In addition to having responsibility for the general and exclusive management and administration of the Scheme and for the specific duties mentioned herein, the Trustees shall have and be entitled to exercise all the powers, rights, discretions and privileges vested in them in accordance with the Trust Deed and the Rules. Such powers, rights, discretions and privileges shall be exercised in conformity with The Trustee Act, the Retirement Benefits Act and Regulations and the Income Tax Rules and any other relevant legislation. In addition, the Trustees shall:
- Determine whether or not any person claiming a benefit from the Scheme is entitled thereto in accordance with the Rules;
- Ensure the correctness of and pay or provide for the payment of the benefits prescribed by the Rules;
- Ensure that proper control systems are employed by them or on their behalf by their agents;
- Ensure that contributions are paid timely to the Scheme Custodian in accordance with the Rules and the provisions of the Retirement Benefits Act and Regulations and the Income Tax Rules;
- Ensure that adequate and appropriate information is communicated to Members informing them of their rights, benefits and obligations in respect of the Scheme and to arrange annual general meetings of the Members in accordance with the Retirement Benefits Act and Regulations;
- Ensure that adequate and appropriate information relating to the Scheme’s affairs is communicated to the Founder.
- The Trustees may make regulations not being inconsistent with this Deed and the Rules for the conduct of the business and administration of the Scheme.
- The Trustees may form committees to help in managing the daily activities and ensure that issues are discussed conclusively.
In simple terms
- To act by majority
- To augment benefits
- To insure benefits, where necessary
- To amend the Trust Deed and Rules
- To appoint advisors
Discretions of Trustees
- Exercise discretion in a fiduciary manner
- Areas of discretion: –
- Appointment of advisors
- Investment matters (Varies)
- Ill-health early retirement
- Augmenting benefits
- Waiving of eligibility conditions
- Death in service benefits
RISK LIMITATIONS FACTORS FOR TRUSTEES
- Take professional advice
- Always act in accordance with Trust documents
- Exercise “duty of care”
- Be reasonable
- Recognize conflict of interest and deal with it
RETIREMENT BENEFITS ACT IMPLICATIONS FOR TRUSTEES
- Form of Trusteeship
- “Whistle blowing”
- The penalties
- Scheme rules may not confine eligibility on the basis of gender, race or religion
- Membership may not be subject to any discretionary power
- Qualifying period – maximum one year
- Trustees must accept transfers in or out of the scheme
- Full vesting of employer benefits
- Non assignability of benefits
- Leaving service benefits – immediate payout
- Payments to nominated beneficiary on death
- Discretionary benefits
- Commutation formula (1/4 for non-contributory, 1/3 for contributory, commutation terms)
- Schemes to keep proper books and accounts
- Appointment of auditor and notification to RBA
- Prepare and audit annual accounts
- Financial statements to be prepared in prescribed format with required disclosures (e.g. un-remitted contributions, fee paid to or on behalf of trustees, related party transactions)
- Audited accounts with certificate by Chairman of Board of Trustees to be submitted to RBA within four months of scheme financial year end
- Inform members of availability of audited accounts for inspection
- Send summary of audited accounts to members with benefit statements
ROLE OF SERVICE PROVIDERS
Scheme Cash Flows Model
Role of Fund Administrator
- Contributions crediting to the members’ accounts
- Income allocation and issuance of member statements
- Computation and payment of members benefits
- Management of member relations for members
- Member communications and Education
- Keeping and updating of records i.e. Forms
- Planning and management of scheme meetings
- Scheme compliance management
- Prepare and submit reports to trustees and Regulator.
- General Duties.
- Ensure that legally binding documents are professionally prepared and executed.
- Ensure that actuarial valuation and audit reports are prepared as required by law.
- Ensure compliance with legislation and advice to trustees of any legislative changes.
- Review from time to time general provisions of scheme.
- Advise to members on options available to them in light of the existing laws.
Investment Accounting Services
- Scheme cash flow management in liaison with the fund manager
- Maintaining the scheme books of accounts.
- Reconciliations with bank accounts and service provider’s reports.
- Facilitate audit to meet the regulatory deadlines i.e. RBA, KRA.
- Prepare and submit quarterly detailed reports to the trustees.
- Prepare & submit schemes financial statements to the auditors
- Scheme compliance management
ROLE OF FUND MANAGER
- Advise Trustees on the available Investment options
- Analysis and Identifying securities to construct the best portfolio
- Constantly reviewing the portfolio and making suitable asset allocation changes.
- Invest scheme assets in line with IPS and RBA
- Report to Trustees on the performance of the scheme funds.
- Submit appropriate quarterly returns to RBA.
- Ensuring the Scheme deliver’s sustainable real returns over the long-term
ROLE OF CUSTODIAN
- Holds investments securely on behalf of the scheme and is able to account independently for any financial transactions.
- Income collection: dividends and coupons due on securities
- Tax recovery – recovery tax which can be reclaimed
- Cash management – management of the cash account
- Settlement of securities – administration of the actual exchange of cash for securities when a security is traded
- Foreign exchange – settling foreign exchange deals
- Pooled funds eliminates the need for a separate custodianship arrangement.
The objective of a retirement scheme is to provide benefits to employees, beneficiaries or dependents at normal retirement age, leaving employment or upon death. The purpose of a retirement scheme is to ensure that retirees enjoy a certain level of financial security that will ensure a comfortable life in old age and removes total dependence on relatives and the society.
There are four main types of retirement schemes:
- Pension Schemes – It pays a periodic sum of money at retirement, usually monthly, quarterly, semiannually, or annually. The law governing pension schemes state that at retirement a member may commute 1/3 of his savings in scheme, but the remaining 2/3 must be used to purchase an annuity (pension) for life.
- Defined benefit pension scheme (salary related) or final salary.
This promises a pension benefit based on a formula that is related to the accrual rate or pension factor, level of salary and years of service with the employer. For example, it may offer 1/60th of final salary for every year of service. If you have worked for the employer for 20 years, you would be entitled to 20/60 of final salary. The employer has the responsibility (bears the risk) to ensure scheme is fully funded.
- Defined Contribution pension scheme.
This type of scheme merely arranges for contributions to be made by both employee and employer and then see how much is there in the account at retirement age and then use the money to buy a pension. This is a risk for scheme members: there is no knowing how the contributions which are invested will perform or what pension or annuity rates will be at retirement. Trustees must manage investments properly.
- Provident funds – A provident fund provides a cash lump sum at the end of the period. On retirement the employees will be entitled to the benefit built up by contributions paid by him or paid on his behalf and the accrued interest. Usually the provident fund is defined contribution based on money purchase. This means that the employer by himself or in conjunction with the employee will pay into the fund fixed percentage of employee’s salary e.g. 5%, 7.5%, 10% etc. In the event of a member leaving the employer’s service before retirement age (whether pension or provident fund), he is entitled to that part of the benefit built up by his own contributions and 50% of the employer’s portion. The other half (50%) of the employer’s portion is preserved till retirement age.
- Individual Pension plans –
- Tax sheltered retirement plans designed to allow individual members to build up assets for retirement.
- Established by private sector financial institutions (e.g. banks, insurance companies or fund managers).
- Managed by a Corporate Trustee.
- Contributions can be made by the member, employer or both.
- Member gets tax relief on contributions and investment earnings.
- Members can choose their own flexible retirement age (50 – 75 yrs). 7. At retirement member can access funds: – Portion in lump sum cash – Portion in pension benefits Benefits may be left to a named beneficiary
- National Social Security Fund (NSSF) –
- A social security fund established by statute in 1965.
- Designed to provide social security benefits to workers in the formal and informal sectors.
- Operates under a Board of Trustees – 3 partners are employers, government and workers.
- Fund investments made per the Retirement Benefit Authority’s investment guidelines.
- Mandatory for all employers to remit contributions. – Contribution rates are 5% of monthly earnings up to maximum of 200 shillings per month.
LEGISLATION AROUND PENSION ARRANGEMENTS IN KENYA AND EAST AFRICA
What are the objectives of Retirement Benefits Authority?
- To regulate and supervise the establishment and management of retirement benefits schemes;
- To protect the interests of members and sponsors of retirement benefits schemes;
- To promote the development of the retirement benefits sector;
- (To advise Cabinet Secretary for The National Treasury on national policy to be followed with regard to the retirement benefits sector; and,
- To implement all government policies relating to pension.
NB: *Sponsor is a company or employer that sets up a retirement plan.
How does RBA ensure safety of pension funds?
The safety of a pension fund is enhanced by its structure. The Trustees of the pension fund play a key role in safeguarding the interests of the fund’s members at all times.
They are required to appoint an independent professional company, known as the Fund Manager, to invest the scheme funds, and an independent bank known as the Custodian, to look after the pension assets such as cash and other investments.
In addition, a Fund Administrator is appointed to maintain accurate records of all contributions made by members and all benefits paid to them. The Fund Manager operates under specified investment guidelines developed in line with the objectives of the particular scheme, to ensure that the manager acts in the interest of the members.
This separation of roles ensures good governance, transparency and accountability with regard to decisions made on behalf of members.
What is the relevance of RBA to the country?
- RBA was created as part of the Government’s financial reforms to mobilize domestic savings, develop the capital market and enhance economic development.
- The primary objective of RBA is to protect the interest of members and sponsors of schemes, to develop the sector and to alleviate old age poverty through enhanced saving for retirement.
- Prior to the creation of RBA, there was no harmonized legal framework governing the sector. This resulted in the well-documented cases of misappropriation of scheme funds, dubious investments of members’ funds, denial of benefits to members, delay in payments of benefits, and a myriad of other ills within the sector.
Why was it necessary for Kenya to set up the Retirement Benefits Authority?
- Even though some pension schemes have been well managed, there were many cases of inefficient management of schemes. It was therefore necessary to create an institution that would instill discipline and confidence in the industry
- Socio-economic changes have led to the breakdown of the traditional systems of old age support, therefore enhancing the need for well-managed retirement benefits schemes.
- Newspapers were replete with reports of denied or delayed benefits, misappropriation of scheme funds, diversion of scheme funds into sponsors’ (employers’) businesses, underfunded schemes that could not meet their obligations, questionable investments, lending of scheme funds to trustees or senior managers at uneconomical rates, and many other problems that were detrimental to members.
- The objectives of Retirement Benefits Act are to encourage long-term savings for retirement, and to protect members and sponsors from abuses that have occurred in the past.
How safe are benefits left in a scheme?
- The retained benefits are kept in the retirement benefits scheme that a worker is a member of just like when he/she was still working for the company;
- Retirement benefits schemes are run by trustees, of whom 50% are nominated by the members, and 50% nominated by the employer. The Government does not appoint trustees or get involved in running schemes;
- The trustees are required to appoint an independent professional company, known as the manager, to invest the scheme funds, and an independent bank, known as the custodian, to hold the assets;
- The individual who has left his/her benefits in a scheme will still remain a member of the scheme and will have rights to nominate or serve as a trustee, receive the summarized annual audited accounts, receive an annual benefits statement and attend the mandatory scheme Annual General Meeting;
- No one can access funds left by an individual in a scheme. The funds remain safe and the individual continues having rights to nominate or serve as a trustee, receive the summarized annual audited accounts and receive an annual benefits statement.
So, where does the Retirement Benefits Authority fit into in all this?
- The Authority is the regulatory body charged with protecting the retirement benefits of scheme members. The Authority oversees the pensions industry, to ensure individual members’ rights are protected;
- The Authority does not hold members’ funds; neither does it instruct schemes on where to invest;
- If a member has a problem with his/her benefits, he/she should engage the trustees and if not satisfied, lodge a complaint with the Authority, which will take up the issue; and,
- The Authority has powers to sanction and prosecute any trustee, or any person who fails to follow the law with regard to retirement benefits.
Can a scheme withhold a member’s benefits on behalf of a sponsor due to, for example, unpaid loans or fraud?
No. The scheme is a separate entity from the sponsor, and the sponsor does not have any right to interfere with the benefits. This also applies to any other person whom the worker may owe money. Retirement benefits are supposed to provide for the worker in retirement and once these are vested in a member, they belong wholly to that member. Employers can recover owed amounts from other terminal benefits, or through the courts, as is the case with other creditors.
Why does RBA find it necessary to set investment guidelines while schemes are already required by the Act to use the services of professional managers?
Investment guidelines in the Retirement Benefits Regulations only provide maximum exposures for the broad asset classes that a scheme can invest in. The guidelines are only meant to ensure adequate diversification among various asset classes. Indeed, schemes are free to choose which particular broad classes to invest in or which to exclude altogether, depending on their specific liability profile. Further, the schemes retain full discretion as to which investment to make within any particular asset class. With regard to the maximum percentages that have been set for the particular asset classes, the views of stakeholders were incorporated in determination of the limits.
How is RBA handling schemes that are holding property in excess of required level?
The Retirement Benefits Regulations allow for a maximum of 30% of the scheme fund to be invested in property. This is in line with the principle of diversification of investments to minimize risk and safeguard members’ benefits. Schemes that are above this maximum do not have to sell their properties, but can submit a proposed action plan to the Authority, showing how they will come into compliance within a specified time through, for example, diverting new contributions and income to alternative investments.
How does RBA charge schemes levy?
The Retirement Benefits Act makes provision for a levy on schemes. In the regulations, the Authority has come up with a graduated levy that declines with scheme size. The levy should be viewed as a small fee for services provided by the Authority to the schemes, their members and sponsors. These services in the form of trustee training, member education, research on investments and other issues of benefit to the sector, negotiating for tax incentives and providing appeals mechanism for aggrieved scheme members. The Authority will also provide service to schemes indirectly through its regulation of the sector, in order to protect the interests of scheme members and sponsors.
Why is the levy based on assets and not income?
Use of scheme assets is the most equitable base since those schemes with large membership or higher wages will automatically have higher assets and will therefore pay a higher nominal levy. The highest levy rate is only 0.2% of assets, and it is extremely unlikely that a scheme with a properly diversified portfolio would have such a low rate of return on its investments. The effective levy rate reduces as schemes grow larger, thus acting as an incentive to the development of schemes.
It is claimed that compliance with RBA Act, particularly the separation of service providers’ roles, will lead to increased costs to schemes. Is this true?
The Authority is aware that some initial expenses will be incurred, for example, in amending scheme rules, conducting an actuarial review, and transferring assets to a custodian. However, this should be seen as one-off cost of streamlining the management of schemes. Service providers such as managers, custodians and actuaries have already entered the market in large numbers to provide the required services to schemes, and this enhanced competition should continue driving prices down. The resultant benefits such as higher investment returns, enhanced transparency, accountability in scheme affairs and protection of benefits have by far outweigh any perceived increase in costs.
Is RBA’s involvement in the running of schemes excessive?
RBA is only a regulatory body for the industry and is not involved in the day to day running of the affairs of the schemes.
The Authority’s approval is not required for matters governing the scheme rules, except where payment is made to the sponsor as a result of winding up of a scheme. Each scheme is however required to file its Trust Deed and Rules with the Authority upon registration.
Is it true that if I change my job I cannot access my benefits until I attain retirement age?
- If you have been a member of a scheme for less than one year, you are entitled to benefits vested in you. To encourage saving for your retirement, if you have been a member of a scheme for more than one year and leave employment before attaining retirement age, you will access your own contributions, plus 50% of employer’s contribution. In a defined benefits scheme you will access 50% of accrued benefits.
- The balance of employer’s portion remains in the scheme and will continue to earn interest payable to you on attaining the retirement age. However, should you retire on grounds of ill health, or permanently emigrate out of the country, you will be allowed to access your full benefits.
NB: You also have the option of transferring your benefits to another registered retirement benefits scheme of your choice.
Insurance Regulatory authority
The insurance industry in Kenya is a major provider of retirement benefits schemes. The retirement benefits offered by Insurance companies guarantee the funds put into the scheme by clients and offer a minimum rate of return as well. A good number of Life Insurance companies in Kenya offer Retirement Benefits Schemes; this includes Employer Pension Plans and Personal Pension Plans.
Most Insurance Companies operate a pension fund called Guaranteed fund.
A retirement benefit scheme can be seen as a form of insurance; you pay premiums while you are working to cater for the period when you will not be earning later in life. The scheme protects members against the risk of poverty in old age by ensuring that they are able to provide for themselves in retirement.
Schemes fully invested in guaranteed funds are exempted from having fund managers. Schemes that invest all their assets in guaranteed funds of approved issuers do not need to appoint fund managers. The approved issuer will be required to submit half-yearly investment reports to the Authority.
The industry has been undergoing reforms under the budget bill proposal
TOPICAL FEATURE ON FUTURE OF PENSION ADMINISTRATION
- Mobile Technology
- Payment of contributions and benefits through RTGS- reducing the risks
- Sending benefits statements through email – keeping green
- Information to members – Notices of AGM
- Online statements and balances
- Pensions Calculator and projections
CHALLENGES IN THE PENSION INDUSTRY
- Coverage – 15% of labor force
- Consumerism /Poor Savings Culture
- Luxurious & comfortable lives in the present as opposed to saving especially among the youth
- 63% of employed single youth currently saving, most saving in banks due to easy access of funds very few think about retirement
- Women saving more than men (cultured to save and are more careful with expenditure
- Low Replacement Rates – 20 – 30% against ILO recommended of 50%-60%
- Health Insurance