This article is borne out of the different options people consider for their retirement income and how appropriate it can be or otherwise. One reason people struggle financially in retirement is the inability to identify the right financial products.
The various notable retirement planning options include existing business, investment into equities, bank savings, property and even children. This edition looks at the downsides of fund accumulation using bank savings as an option. Remember that no option is bad in itself, but the failure to identify and mitigate the risks inherent in the options. The article looks at what pension schemes in Ghana can offer in relation to bank savings.
Pension funds in Ghana
Contributing to a pension fund is one of the very reliable sources of income during retirement. What is the difference between a pension fund and regular bank savings?
There is a downside to using bank savings as a retirement income. Funds in a savings account are exposed to the risk of inflation and the risk of shortfall*. For what we term defined benefit (DB) schemes, the risk of shortfall is somewhat mitigated as benefits are based on qualifying criteria. An example is a 1st tier SSNIT benefit where one qualifies after contributing for 180 months. The level of benefits is based on a pre-determined formula that uses the best three (3) years’ salary. Benefits are thus guaranteed and one risk of shortfall is weaknesses in administration and data management.
Pensiion funds in Ghana – Defined-Benefit Schemes
The level of benefits under the defined – benefit is also index-linked. Periodic adjustments would be made based on inflation or an underlying market rate. Again due to the fact that the government is involved with SSNIT, benefits are assured. This somewhat insulates the benefits from the loss of purchasing power, though not entirely in our part of the world. There seem not to be much to worry about here.
Pension funds in Ghana – Defined Contribution Schemes
The situation is however different from the other sibling called the defined contribution (DC) scheme. In Ghana, both the 2nd and 3rd tier schemes are defined -contribution. Benefits depend on how much funds are accumulated and the investment returns (less all charges to the scheme). It has no qualifying benefit criteria except that one should have contributed. Therefore, your proceeds depend on how well your pension scheme is managed.
Pension funds in Ghana – The Risks
With these schemes the risks of inflation and shortfall in addition to investment risk are real. The risks reside in the general economic and investment climate as well as the performance of the pension trustees and fund managers. The pension fund managers usually advise pension trustees to invest the funds for returns usually higher than inflation. If you should keep Ghs100 in a cabinet for 3 years without any additions, the value (purchasing power) drops.
Therefore the Ghs100 cannot do in 3 years’ time what it can do today. The purchasing power will be eroded and eaten up by the inflation dinosaur. This animal has sharp teeth! A good way to keep the Ghs100 strong is to invest and make some returns. A better way, however, is to invest the Ghs100 and make returns higher than inflation.
The inflation rate at the end of September 2021 was 10.6%. In order to keep the Ghs100 going at its appreciable strength, returns on it should be more than 10.6%.
Pension Funds Vrs Bank Savings
i. NPRA Guidelines regulating Pension Funds
The guidelines permit schemes to invest up to 75% of the funds in Treasury instruments and 20% in equities (shares/equities of organisations). A good combination of these as well as other permitted asset classes in pension fund management would yield a lot higher than the regular bank savings would give you.
Additionally, the assets are highly regulated. The regulations protect the fund from unnecessarily high-risk taking, as well as services charges. These are all value to the scheme which monetary benefits become tangible over the medium to long term.
With good management, a typical pension scheme could yield anything from 19% per annum. This is much higher than the 5-8% offered on typical savings at the bank. Regular bank savings play a role in accomplishing other financial objectives but definitely not accumulating funds for such long-term life objectives as retirement.
ii. Compounding of Pension Funds
Again, with the compounding effect on pensions fund returns and the continuous contributions, pension funds grow exponentially. For those not in any formal sector employment, there is the need to immediately lookout for a private pension scheme to join. The NPRA website has amply provided information on trustees you can register with. If you are already in a formal sector arrangement it would be a good deal to look out for the extra 3rd tier to contribute more (if there is still some allowance on tax).
iii. The Banking Failure
The failure of some financial institutions lately should also inform where you place funds, else they would be wiped out before the time they are needed. Bank savings is useful when retirement benefits are paid and one wishes to place a portion in a savings account for easy access to funds.
Instead of regular savings for a long-term accumulation of funds, consider contributing to a pension fund. The points discussed above explain why Bank Savings is not a Good Retirement Planning Option in Ghana.
*Inflation Risk: also called purchasing power risk, is the chance that the cash flows from an investment won’t be worth as much in the future because of changes in purchasing power due to price increases.
*Shortfall Risk: Retirement shortfall risk is the potential that when someone retires, he/she will not have enough assets or income as previously expected for their retirement.
*Rates are as of September 2021