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Why might my capital be insufficient to retire?

Making adequate provision to retire with dignity is not so easy to achieve in the first instance. It requires adequate funding by employer and employee throughout the employee’s working life, it requires that not too much but also not too little of the contributions be diverted for other purposes and benefits, and that the capital accumulating for retirement does not experience any leakages.

The following are typical pitfalls that will prevent you from achieving this ideal:

  • early withdrawal of accumulated capital,
  • poor investment returns,
  • high management costs,
  • too low a basis for setting a contribution rate,
  • too low a contribution rate,
  • statutory disincentives and, importantly
  • leakages in the system.

Government needs to take measures to prevent leakages

At an RFIN breakfast seminar reported on below, the Ministry of Finance expressed its concerns how to ensure that government doesn't end up bearing the responsibility for persons that have made inadequate provision for their retirement.

We have on various occasions in the past dwelled on the topic of the proposed National Pension Fund, one policy measure government is considering in order to ascertain that all citizens will eventually have provided adequately, to retire with dignity. Clearly there is serious and justified consideration how to go about this national objective. And it does not take much gray matter to appreciate that the approach must be two-pronged, one being to ascertain that everyone contributes adequately, the second one being to plug the holes in the system that cause leakages.

The RFIN breakfast session dealt with the topic of preservation of retirement capital upon resignation. Currently, there is no legal requirement to preserve one’s capital upon resignation. The Income Tax Act encourages preservation by allowing retirement capital to be transferred to another approved fund, tax free but at the same time it allows you to withdraw a portion or all your capital within the first three years of resignation. This is only one leakage. The National Pension Fund envisages compulsory preservation but it is not in force.

A much more serious leakage is the provision for provident funds in the Income Tax Act. These funds cannot pay pensions but only lump sums and oblige the employee to accept cash as the default arrangement. Obviously most employees are unlikely to reinvest the cash once in their possession. We question the existence of provident funds. The Act also discourages members from providing adequately

for retirement by a very low cap of N$ 40,000 on tax deductible contributions and by disallowing additional voluntary contributions for tax purposes but tax any benefit without any regard to such after tax contributions made by the member.

Another serious leakage is caused as the result of the Income Tax Act not prohibiting pension funds to pay death benefits and disability benefits as lump sums and on top of it, ‘creaming’ off income tax on such lump sum benefits. So even if the employee/dependant wants to reinvest the capital, a portion will be given up in income tax.

There are other less serious leakages which we will not cover now. The most serious leakages can and should be addressed by government through policy measures. The thought has been raised for the Income Tax Act to do away with provident funds. It is also likely that the larger portion of any benefit to be offered has to be an income benefit with only a smaller portion in form of a lump sum. With regard to the National Pension Fund, it is still being contemplated whether or not any exemption will be granted to existing funds. It would appear likely that if any exemption were to be granted, it would be on the basis that employee and employer contribute rate towards the fund is at least equal to that of the National Pension Fund (12%-14% of payroll?) and that benefits will primarily take the form of income rather than lump sum benefits.

Trustees need to look at their fund benefit structure

Often pension funds require the retiree to purchase a pension from another fund or insurer. Such transactions not only often expose the retiree to unscrupulous operators, but the retiree will incur substantial costs. Trustees are also often overwhelmed by consultants talking them into unnecessarily complex structures that might serve the needs of a very small minority but come at a cost. Trustees often do not grasp the complexity of such structures nor do they appreciate the risks and the costs attaching to such complexity. The consultants often introduce such arrangements with their own agenda, such as selling their house products and services and making themselves indispensable for the fund.

Trustees of course are free to pre-empt legislative measures to plug these leakages that are likely to be addressed through government policy measure sooner or later. In this light, here is sound advice to employers until such time as the future of the National Pension Fund and of the Income Tax Act with regard to retirement provision has been cleared:

  • Rather offer a pension fund than a provident fund.
  • The pension fund should offer income benefits rather than lump sums in the event of death, disablement and, as a matter of course, in the event of retirement.
  • Be wary of converting your fund from pension fund to provident fund and to do away with income benefits.
  • Be wary of outsourcing pensioners if your fund is large enough to carry the liability for in service spouse’s and children’s pensions and post retirement pensioners.
  • Be wary of dissolving your investment reserve which is particularly useful for funds maintaining a pensioner pool.
  • Be wary of unnecessarily complex and expensive fund structures that may serve a small group of members only.

Once abandoned, it will be extremely difficult for any fund to reintroduce the previous arrangements.
 

Important notice and disclaimer
This article summarises the understanding, observation and notes of the author and lays no claim on accuracy, correctness or completeness. Retirement Fund Solutions Namibia (Pty) Ltd does not accept any liability for the content of this contribution and no decision should be taken on the basis of the information contained herein before having confirmed the detail with the relevant party. Any views expressed herein are those of the author and not necessarily those of Retirement Fund Solutions.

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