A retirement plan is a type of investment and savings plan that enables people to save for retirement. By contributing to a retirement plan, one will receive a steady income or lump sum when one attains retirement age. The main purpose of a retirement plan is to provide you with money regularly after you retire.
The exact amount of the retirement scheme contribution and when it will be paid are determined by your employer and will depend on your age, retirement age, and years of service. Whether private or company-provided, a retirement plan can be a life-changing decision.
As you near retirement, you should consider what type of financial plan you have set up. If you do not have a pension plan through work, it is something you must look into. But what exactly is a retirement plan?
What is a retirement plan?
A retirement plan allows you to set aside money during your working life to fund your retirement. Once you retire, then the funds are paid at regular intervals or as a lump sum, depending on the retirement scheme.
When looking for a retirement plan, you should consider factors such as your lifestyle, age, the amount you want to put into your retirement, or the risk you want to take.
In Kenya, retirement schemes are regulated by the Retirement Benefits Authority (RBA).
Types of retirement plans
In Kenya, retirement schemes are either private or public. The private retirement plans are administered by private companies, while the public retirement scheme is government administered. Retirement benefit schemes are divided into defined benefit (DB) plans, defined contribution (DC), and provident funds.
Here is a brief description of each category of retirement plans.
1. Defined-benefit plan (DB)
In a defined-benefit plan, an employer guarantees the employee will receive specific monthly payments after retirement. This is regardless of how the underlying investment pools perform. The defined benefit is what is commonly referred to as a pension plan.
Your employer is held liable for the specific flow of your pension payment. The employer determines the pension payments by considering your years of service and earnings. If the retirement pool doesn’t have enough money to pay for your retirement, then your employer is held accountable.
- Annual contributions do not have a limit.
- The administration cost is higher.
- specifies how much an employee will receive once they retire.
- Employers’ contributions are limited to 25% of one’s salary.
2. Defined contribution (DC) plan
In the defined contribution scheme, an employer and employee each contribute a percentage of the employee’s pensionable earnings. The employer is obligated to make specific contributions for each employee covered by the plan. The employee’s contribution can match this contribution.
The closing benefit received by the employees is not known in advance and relies solely on the performance of the investment plan. The amount receivable by the employee depends on
- Level of the contribution made over the accumulation period
- Fees and expenses of the product provider
- Investment returns during the period of accumulation
- Annuity rates at retirement
The liability of the company ends when they make the payments as planned. It is the most common pension in Kenya, as many employers prefer it to the defined benefit pension plan.
- specifies how much the employee and the employer should contribute to a plan. In Kenya, the contribution is a percentage of the pensionable earnings.
- One does not know the amount to be received after retirement.
- Employer contributions are limited to a maximum of 25% of an employee’s salary.
- lower administration costs.
- One can e whether they want a lump sum payment or a pension option.
- If one dies, their spouse can receive their pension for close to 21 years, or it can be paid out to their children under 18.
A provident fund is a type of retirement plan in which an employee receives a lump sum as well as other benefits when they leave their job. The money can also be given to dependents in the event of one’s death.
Retirement contributions are payable on:
- Voluntary early retirement from age 50.
- One retires due to medical conditions after one year of service.
- Death of an employee who had served for one year.
- Retirement on medical grounds and after at least one year of contributory service.
How do retirement plans work?
How pension plans work depends on which category they fall under. It can be under a defined-benefit plan or a defined-contribution plan.
When you start working for a new company, there may be a time limit on how long you must work for the company before you are eligible for the workplace pension.
A traditional pension plan is a defined benefit plan. It guarantees that you, as the employee, will receive a stipulated amount once you retire, regardless of your investment performance.
Defined – benefit plan
In a defined benefit plan, the employer guarantees the employee a set amount of money for a set period after they retire. The employer will ensure the employee receives the specified amount despite the performance of the underlying pool of investments.
Both the employee and the employer contribute to the pension pool, which the employer administers and manages.
Once the employee retires, even if they are not working for the same company, they can file for defined pension plan benefits. In case the assets in the defined benefit plan are not enough, the employer is liable to pay the remaining amounts.
Defined contribution plan
In a defined contribution plan, the employer commits to making certain contributions for each employer under the plan. The employee may be required to match the contribution. On retirement, the employee will receive benefits based on the performance of the investment.
In a defined contribution, the companies are not held liable. Most companies opt for the defined contribution plan because it is less expensive.
Once you have retired, you can be offered the chance to pick whether you want monthly payments or one lump sum.
Do I need a retirement plan?
The answer to this question is a resounding yes. Retirement plans are designed to provide security for you in your later years when you no longer have an income from work. Here is why you need a retirement plan:
- Contributions are tax-exempt.
The contributions you make towards your retirement are tax-exempt. You get a tax break from your contributions.
- Secure your future.
Your retirement plan ensures you have a secure future. Planning your retirement allows you to continue living the same lifestyle you have now.
How to choose a retirement plan
Choosing a retirement plan requires one to compare the different types of schemes available, including the fees charged, contribution limits, and how the account should be managed.
If there is a work pension, the employer will choose the plan provider, but if you’re thinking of opening a private retirement, then the decision is solely up to you to decide what pension plan meets your needs.
When picking a plan, you should take into consideration the following factors:
a) The investment plans
This focuses on how your money is invested and whether the investments are diversified among different assets.
b) Performance of the retirement scheme
Does the retirement scheme have a good track record? Although we can’t determine future performances based on the past, it is essential to ensure that your plan does well.
c)Retirement plan fees
It is important to consider all charges. Some plans may come with hidden costs; therefore, you should read the fine print. Also, consider whether there is an exit charge should you choose to exit the pension plan.
d) Levels of contribution
Does the plan you choose have minimum or maximum payments? Is it possible for you to pay lump sums and regular contributions?
You should be able to answer those questions before selecting any pension fund.
e) Employers’ payment
Is it possible for your employer to pay your contributions into the pension, or is it a private pension?
If your employer doesn’t pay your pension, you should consider a private pension fund, but if they do, you can go with whatever plan they offer.
Retirement schemes in Kenya
Below are companies offering retirement plans in Kenya.
- ABSA Asset Management Limited
- Britam Asset Management Kenya Limited
- CIC Asset Management Limited
- Co-operative Trust Investment Services Ltd.
- ICEA Lion Life Assurance
- Madison Investment Managers Limited
- Old Mutual Investment Group Limited
- Sanlam Investment East Africa Limited
- Zimele Asset Management Company Limited
In conclusion, a retirement plan is a financial plan that helps you save money for retirement. There are many different types of retirement plans, but the most important thing is to get one that fits your needs. Get started today by talking to a financial advisor about retirement planning.