Understanding Annuities

What the Law Stipulates About Payment of Pension upon Normal Retirement Age

Upon attaining the normal retirement age of 60 and 55 years for those who were in the pension scheme prior to 1^st January 2016, a member retires and is due to receive his or her long awaited pension. The pension amount is derived from the accumulated credit and converted to a monthly pension payable until a member dies.  If the derived pension amount is below K5,000.00 per annum, the pensioner can encash the full accumulated credit as a lump sum. This is a full refund.  However, if the derived pension exceeds the K5,000.00 per annual pension, then a member will be entitled to a 50% cash pay-out and the other 50% will be used to purchase an annuity.

An annuity is a series of pension payments, usually payable on a monthly basis, from your retirement until death. An annuity is an insured financial product that enables a retiree receive income on a regular basis, (either monthly, quarterly, semiannually or annually)

How Pension is paid:

 

When one reaches Retirement Age, visit your HR Department nearest to you;

• (i) Discuss options available.
• (ii) Complete claim form together with Officer.
• (iii) Sign your form stating your choices clearly.
• (iv) Give bank details.
• (v) Indicate your cell phone number for easy follow up.

 

Pension and the Law

• Pension must be paid for life.
• Pension is tax free.
• Payable at medical retirement, early, normal or late retirement.
• Where pension is below K5,000.00 per annum, total accumulated credit may be paid up to 100% lump-sum.
• K50,000.00 currently provides pension of K5,000.00/Annum.
• The Fourth Schedule of the Income Tax Act provides that the Commissioner-General will only approve a pension fund whose main objective is to provide payment of pension to its members on retirement from employment.

The accepted definition of a “pension” is a payment of a regular income after retirement (and not a lump sum payment).  The purpose of this is social protection, to ensure sustenance into old age, when most individuals will no longer be in a position to earn any other income.

Payment of Pension

The Pension payable on a Member’s retirement shall be purchased by the Scheme from a Registered Insurer in accordance with the Member’s retirement options elected.  The terms and conditions applicable to such Pension, including options elected by the Member and the determination of any benefits arising on his death, shall be subject to the requirements of the Revenue Authorities and shall be set out in writing by the Registered Insurer.

1. Each such annuity shall be payable by equal monthly instalments on the last day of each month, unless otherwise agreed.
2. The first monthly instalment of an annuity payable to a Pensioner shall be payable on the last day of the month in which the Member dies.
3. No payment of an annuity payable to a Pensioner shall become due after the Pensioner’s death, except where there is a spouse or orphans’ pension.
4. Each Pensioner in receipt of an annuity shall provide such evidence of his survival or continued eligibility as the Manager may require. If such evidence is not produced, then the Trustees may direct that payment of the annuity be suspended until such evidence is produced.

 

Purchasing a Life Annuity/ Pension

The following steps are taken when a member retires and is ready to purchase a life Annuity:

• (i) An Annuity Quotation may be provided to a Member by an Annuity Service provider, which Quotation will enable a Member to select/elect an Annuity amount payable to him based on his options on the Annuity loadings.

 

• (ii) Once a Member is satisfied with the Quotation, and is ready to now purchase an Annuity, an Annuity Application Form shall be filled-in by a Member, and submitted to the Annuity Service provider. The Service provider will be required to prepare a contract between the two parties.

 

• (iii) Once an Annuity is purchased from an Annuity Service provider, a Member shall immediately cease to be a Member of the pension scheme and shall become a member of the annuity fund from which the annuity is provided, and shall have no further Claim on the Scheme. This means that the selected Annuity Service provider would be in control of all future Annuity payments going forward until the Member dies.

 

Example of an Annuity Payment

Pension is bought out of the accrued Funds. Therefore, the higher the accrued credit, the larger the pension. Pension amount payable will depend on the Amount of accumulated credit. The following options may be exercised:

• Single/Non-spouse pension.
• Spouse pension: Option to add a spouse who at the main Members death, becomes eligible to continue receiving his /her pension.
• Guarantee or Non-Guarantee: Option to choose among the following guarantee periods; 5 years, 10 years or 15 years. While pension is payable for life regardless of the time, some pensioners die too soon, e.g. a month after retiring. Questions arise as to what happens to his pension. The choices answer the question.  A choice of 10-year guarantee means the pension will be paid to be beneficiaries until the ten-year period is completed before it ends. The same applies to zero and five year guarantees. The question that arises then is, “Why get a zero or five year guarantee when a ten-year guarantee seems to offer more.  The answer is that the lower the guarantee period, the higher the month pension payable as its spread over a shorter period.
• Escalation rate of say, 0%,2.5%,5% or 7.5%: This is the regular pension increase rate applied on the anniversary every year. The higher the escalation arte, the lower the starting pension amount owing to the fact that it will be increasing at a fast rate.
• A good balance must be struck between guarantee period and escalation rate to understand the best outcome. This can only be achieved with the help of the professional hence the need to ensure a soon to retiree member of the pension fund undergoes retirement training.
• Monthly, Quarterly, Semi-annually (Half) yearly, or Annually: this is the frequency at which a member receives their pension. Many pensioners have preferred monthly pension in line with the monthly salary income practice.

 

Practical Example:

 

Basic Rules:

Same amount payable for a period.

Increases given only when annuity account makes profit.

Profit not a guarantee.

 

Example No.1: Spouse Pension Purchase Price = K467,900.00

Assume the price per K1,000.00 held is as follows;

• –year Guarantee – K73.520

5-year guarantee – K74.52

10-year guarantee – K76.31

 

The you divide the total accumulated credit with the price per K1,000.00.

Pension Payable Per Month

Zero years Guarantee         5,966.15

 

Five Years Guarantee         5,946.59

 

Ten years Guarantee          5,909.36

 

Example No.2: Non Spouse Pension Purchase Price = K467,900.00

Assume the price per K1,000.00 held is as follows;

0–year Guarantee – K78.43

5-year guarantee – K78.68

10-year guarantee – K79.18

 

Pension Payable Per Month

Zero years Guarantee                            6,364.18

 

Five Years guarantee                             6,279.25

 

Ten Years guarantee                              6,131.97

 

Methods used to derive the pension are many but will provide the same result.  The only critical thing to do is to monitor the price competitiveness as each annuity provider will have their own price.

 

What is the case like for a commutation?

The law allows a pensioner whose accumulated credit earns them a pension which is more than K5,000.00 per annum to get a lump sum amount up to 50% of the accumulated credit.  In the example above, if the member elected for a 50% lump sum, then he receives as follows;

• Cash Lump sum = 50% of K467,900.00 = 467,900/2 = 233,950.00
• Reduced Pension for ten year Guarantee = K6,131.97/2 = K3,065.98
• Pension increase at escalation rate of 7.5%

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Year 9	Year 10	total paid
Year 1	3,065.98										36,791.76
Year2		3,295.93									39,551.14
Year 3			3,543.12								42,517.48
Year 4				3,808.86							45,706.29
Year 5					4,094.52						49,134.26
Year 6						4,401.61					52,819.33
Year 7							4,731.73				56,780.78
Year 8								5,086.61			61,039.34
Year 9									5,468.11		65,617.29
Year 10	Calculation = the year’s pension multiplied by the escalation factor.									5,878.22	70,538.58
											520,496.25
Capital sum											233,950.00
Total Pension Increase over ten years (benefit from escalation selected)											286,546.25

 

 

Why is it that the pension has to be bought from an annuity provider and not from the pensions scheme? In the pension scheme all assets are allocated to an individual and none can be paid from the other’s allocation.  There is no common pool from which to pay those who live long hence the need for an insured product.  The insured product means someone else takes the risk of a retiree living longer than anticipated.

Critical Issues to Note

 

 

• Pension continues to be paid for life whether guaranteed or unguaranteed.
• Upon death, the spouse will be paid a % of the spouse’s pension as initially selected, until death: This relieves some of the burdens that come after the departure of a bread winner.
• Pension increases are given during each financial year depending on the performance of the annuity fund or the escalation rate selected where applicable.