Oran Hall | Retirement without a formal pension

Jamaica has made much progress in developing formal pension arrangements for the many people who work and must one day retire, but there are serious questions about how people will survive considering how few are covered by these arrangements.

The Financial Services Commission’s September 2024 Pension Industry Statistics Report gives some good insights into the level of private pension coverage of the employed labour force.

Only 11.69 per cent of the employed labour force was covered. The combined membership of the defined benefit plans and defined contribution plans was 164,501. There were 82 traditional DB or defined benefit plans and 29 other defined benefit plans and 253 DC or defined contribution plans out of the 364 pension plans. The traditional defined benefit plans accounted for 18,985 members and the defined contribution plans for 123,004 members.

There were 349 superannuation funds compared to 15 retirement schemes, that is, 95.88 per cent and 4.12 per cent, respectively. Membership was almost even – superannuation funds 80, 174 or 48.74 per cent and retirement schemes, 84,327 or 51.26 per cent. Superannuation funds, being around for a far longer time, dominate the amount of assets – $695.4 billion or 89.79 per cent, compared to retirement schemes, $79.04 billion, or 10.21 per cent.

Superannuation funds are employer-sponsored funds, and retirement schemes are private pension arrangements open to employed people who are not members of an employer-sponsored pension plan and self-employed people primarily, but employers may make contributions to them for their employees, but not more than 10 per cent of the employee’s salary and not so much that the combined contributions of employer and employee exceed 20 per cent of the employee’s salary.

In a traditional DB plan, the pension is determined by a formula, unlike a DC plan in which it is based on the contributions made by the employer for the employee plus the employee’s contributions, and the interest and capital gains and losses earned on them. Superannuation funds may be defined benefit or defined contribution, but there is a trend away from the former to the latter. Retirement schemes are defined contribution.

In all of these pension arrangements, the contributions are invested and managed by professional investment managers. Securities dealers managed 55.16 per cent of the funds at September 30, and insurance companies 36.83 per cent.

People who do not save for retirement using these arrangements have other options; they may engage professional fund managers to manage their portfolio, or they may do so themselves.

Professional fund managers manage funds for a fee. Although some have established funds that their clients buy into, limiting the scope for customisation, others create customised portfolios for their clients. Individuals who do not have the skill or time to manage their portfolio tend to opt for this approach.

Pooled funds, like unit trusts and mutual funds, provide another option. There is a wide range of such funds, and although individual funds are not customised to the needs of investors, they may choose to invest in several funds to create a portfolio that comes close to reflecting their ideal portfolio. Even individual funds tend to be diversified, which tends to reduce risk. They tend to be quite liquid, meaning they can be converted to cash easily. This can be good as it allows for the investor to make changes to the portfolio with little difficulty. It can be bad too: the ease of conversion can cause indisciplined people to divert funds to purposes other than retirement.

There are other useful sources which can provide retirement income, directly or indirectly, for example, life insurance, the NIS or National Insurance Scheme, and the NHF or National Health Fund, which provides benefits for all eligible Jamaican residents.

Some life policies generate cash values which policyholders may be able to convert to cash leaving the sum insured for the benefit of their beneficiaries. Equity-linked policies may also generate a good source of income through the encashing of units, but care should be taken not to put the policy at the risk of lapsing. There are also endowment policies that mature at the end of a specific term, like 15 years. Life insurance companies also offer a wide range of policies which offer lump sum payments in cases of critical illness, for example.

The NIS also pays a small pension to its contributors as well as a pension to those who become widowed. Its contributors are also eligible for several benefits through the NI Gold Insurance Plan. They include in-hospital room and board, surgeon’s and assistant surgeon’s fees, prescription drugs, optical and dental expenses, and diagnostic services. These benefits complement those of the NHF, which provides prescription drugs for a specific list of chronic health conditions.

Approved pension arrangements give significant tax benefits as neither the contributions to them nor the income they earn are taxed. People who are not covered by any may derive tax-free benefits if they invest in stocks and pooled funds that generate capital gains, real estate, if sold, and some interest-bearing instruments, the income from which may be so designated. Earning and re-investing tax-free income is a big deal.

Though it is preferable, not having a formal pension does not have to be a disaster. Starting to save and invest early, doing so consistently, and earning tax-free income can go a far way in building a strong pool of retirement funds.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com