Introduction
IN recent years, we witnessed a drastic global shift in pension policy away from public (state) and private employer-sponsored schemes in which benefits are pre-defined (Defined Benefit or DB) towards private retirement savings plan in which benefits depend on the value of accumulated assets (defined contribution DC). This has transferred significant risk from the state and employers to the employees including inflation, interest rate, investment and longevity risk.
In 2004, Nigeria carried out a reform of her pension industry. Prior to the reform, there was no law defining schemes in the private sector while the public sector operated the defined benefit’s scheme. The reform brought about the enactment of the Pension Reform Act 2004, which was repealed in 2014 and replaced with the Pension Reform Act 2014. The Act in section 3, established a Contributory Pension Scheme, making it mandatory for the public sector while in the private sector for employees of an organisation in which there are 15 or more employees.
What is the Difference Between a Defined Benefit and Defined Contribution Schemes?
Defined benefit plans define the benefits ahead of time: a monthly payment in retirement, based on the employee’s length of service and salary for life. Their right is not an account, but to a stream of payments based on budgetary allocation. In defined contribution, the benefit is not known but the contribution is. In defined contributions, the employee’s contribution and employer’s contributions are both invested on behalf of scheme members and on retirement, the proceeds of the investments together with the contributions are used to buy a pension.
Nigeria’s Contributory Pension Scheme
Nigeria’s Contributory Pension Scheme established under section 3 of the Pension Reform Act 2014, is a defined contributions pension scheme. The credit in the Retirement Savings Account (RSA) is build up through minimum of ten percent and eight percent of monthly emolument of the employee as the contribution of the employer and employee respectively, as stipulated in section 4 of the Act plus investment returns.
What Are the Concerns About the Shift from Defined Benefit Scheme to Defined Contribution Scheme?
Together, these developments raise very significant concerns about adequacy and security of future retirement income at a time when longevity is increasing and when the global experience show low returns and high volatility in investment, reducing public confidence in retirement savings.
What is appropriate policy response?
Since Defined Contribution has become an integral feature of Nigeria’s pension system as is the case with the United States, United Kingdom, Australia, Chile, New Zealand, among others, therefore in view of the concerns raised, what then is the appropriate policy response? The policy responses to these concerns are as follows:
Long term savings: It has to be stressed to employees, employers and policy makers that saving for retirement requires a long term commitment and also that it is important to diversify sources of retirement income. Nigeria has taken the right step by establishing a mandatory Contributory Pension Scheme for the targeted group. Unfortunately, there are compliance challenges with employers especially in the public sector.
Ensure that there is a coherence between the accumulation of savings and the pay-out phase: Effective collection administration, supervision and regulations; a robust investment framework that addresses key risk and inherent uncertainty inherent in saving for pension, which avoid excessive exposure to risk.
Encourage high participation rates and adequate contributions: Contributions should be relative to required income. While return on investment is crucial in a defined contribution scheme, government, employers and employees should strive to achieve long term attractive returns, with prime focus on the variables they can control, i.e. contribution rates and contribution period. A research by Organisation for Economic Co-operation and Development (OECD) suggests that lengthening contribution period by postponing retirement is an efficient approach to increasing retirement income. Postponing retirement simultaneously increases the contribution period and reduces the retirement period to be financed.
Ensure effective Communication to address financial illiteracy and lack of awareness: Majority of the Scheme’s members lack financial literacy and awareness of the provisions of the Act and the workings of the Contributory Pension Scheme. Consequently, there must be effective communication by providing regular individualised statements of accounts; informing members about the possible impact of high contributions. Contributors should have free and ready access to comparative information about cost and performance of different Pension Fund Administrators. The language used in disclosed materials should be readily understood by members of the Scheme.
Advantages of Defined Contribution
The following are some of the advantages of defined contribution scheme:
Portability: Section 14 is the most obvious advantage of defined contribution bestowed on a worker, which is that of portability. Since contributions are paid directly into individual employees’ Retirement Savings Accounts, it is easy for workers to take their accumulated funds with them when they change jobs. As a result, workers get to keep the full past contributions made by the last employer.
Immediate vesting: The employers’ contributions to the individual workers’ accounts become the full property of the workers upon payment. This benefits workers who are not going to stay with one employer for the rest of their lives.
Personal Control: Workers don’t have to worry about politicians taking away their benefits or bureaucrats mismanaging their pension funds.
Tax exemptions: Section 10 provides that contributions to the Scheme are tax deductible; all interests, dividends, profits, investments and other income accrued to pension funds and assets under the Act shall not be taxed and any amount payable as retirement benefit under the Act shall not be taxed.
Workers have choice of their Pension Fund Administrators: Section 11(2) of the Act provides an employee the opportunity to choose his Pension Fund Administrator, while section 13 confers on the employee the right to change his Pension Fund Administrator not more than once in a year.
Challenges of Defined Contribution
At present, defined contribution might not produce adequate outcomes due to some of the following factors:
Contributions are low: The levels of contributions are low. The attempt to raise the rates of contributions has been frustrated especially in the federal public service by the federal government. This is because the government has failed to comply with the provisions of Section 4(1) of the Pension Reform Act 2014, which provides the minimum rates of contribution to be 10% and 8% of an employee’s monthly emolument by the employer and employee respectively. Subsection 2 also provides that between any employer and employee, the rates can be revised upward from time to time. It is doubtful if any employer will on his own raise its contributions. The law made the provision in this subsection in order to give room for employers and employees to, through collective bargaining, increase contributions. Subsection 5 provides that an employee can make additional voluntary contributions to his retirement savings account. Salaries in the country are too low to encourage savings that will lead to voluntary contributions.
Level of public confidence and understanding of defined contribution are very low: People expect somehow a retirement income that will replace around 60-70% of their final salary. However, retirees get 30-40% of final salary as retirement income. This has caused workers to now put pressure to turn the pension scheme to a saving scheme by requesting that retirees be allowed to collect all the credit balances in their RSA or to return to the old defined benefits scheme under the wrong assumption that it delivers higher retirement income, more so when under the old defined benefits scheme employees were not contributing.
Operators, the regulator and policy makers have not sufficiently explained to RSA holders how this is implausible.
Conclusion
The contributory pension scheme which replaced the defined benefits scheme has its challenges, the advantages of the scheme however outweigh these challenges.
Ivor Takor mni, can be reached directly for comments and reactions via Email: takorivor@gmail.com; WhatsApp: 2348037861900. Comments and observations can also be made through the interactive platform on this page.
