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Understanding how different retirement schemes work

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[dropcap]T[/dropcap]he retirement benefits sector represents one of the largest institutional investors in the country. However, despite the important role the sector plays, particularly during sunset years, a large population doesn’t seem to understand how retirement schemes operate. Kenya has different types of schemes that any individual can join. 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.

A 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 organisations 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 organisations 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:

  1. Their registration as either a Provident Fund or a Pension Scheme;
  2. The investment plan of the scheme (guaranteed and segregated funds); and
  3. The design of the scheme (Defined Benefit and Defined Contribution schemes).

Provident Funds vs. Pension Schemes

The fundamental difference between Provident Funds and Pension Schemes is in terms of accessing your benefits at retirement. In a future article in this series, I will spend some time explaining how benefits are accessed in retirement arrangements and go into more detail on the differences between Provident Funds and Pension Schemes.

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.

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In segregated funds, members’ contributions are invested directly by the Trustees via an appointed Fund Manager (as covered in our prior article). 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 Benefit vs Defined Contribution Schemes

The structure of the retirement scheme is determined at the initial design stage when the scheme is being established. Historically, the most common type of retirement arrangement was a Defined Benefit scheme. In the more recent past, there has been a pronounced shift by employers around the globe who have moved away from Defined Benefit schemes. Today, Defined Contribution schemes are the more popular structure for delivering retirement benefits. In the next article in our series, we will have an in depth look at these two common structures for retirement schemes.

NEXT READ: This is how retirement schemes manage your funds

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Adil Suleman
Adil Sulemanhttp://www.businesstoday.co.ke
ADIL SULEMAN is the Head of Actuarial Division at Zamara.
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