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 scheme in Ghana can offer in relation to bank savings.
Contributing into a Pension Scheme in Ghana
Contributing into pension schemes is known to be one of the very reliable sources of income during retirement. What is the difference between a pension fund and a regular bank savings? There is a downside of using bank savings as a retirement income. Funds in a savings account is 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 a qualifying criteria. An example is the 1st tier SSNIT benefit where one qualifies after having contributed for 180 months. The level of benefits is also based additionally on a pre-determined formula using the best three (3) years’ salary. The benefits are thus guaranteed. In this case one risk of shortfall would mostly arise from weaknesses in administration and data management.
Benefits under Defined-Benefit Schemes
The level of benefits under the defined – benefit are also usually index – linked in which case periodic adjustment 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 loss of purchasing power, though not entirely in our part of the world. There seem not to be much to worry about here.
Benefits under Defined-Contribution Schemes
The situation is however different with the other sibling called defined contribution (DC) scheme. In Ghana both the 2nd and 3rd tier schemes are defined -contribution. Benefits depend on how much funds were 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 has been managed. A typical defined-benefit scheme that has so far performed creditably is ‘My Own Pension’ product by United Pension Trustees.
With these schemes the risks of inflation and shortfall in addition to investment risk are real. These 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. Under accumulation of funds if you leave 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 has been eroded, it has been 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. Currently Ghana’s inflation rate is 7.8% so to keep the Ghs100 going at its appreciable strength returns on it should be more than the 7.8%.
A Better Way: Private Pension Scheme in Ghana
A better way however, is to invest the Ghs100 and make returns higher than inflation. Currently Ghana’s inflation rate is 7.8% so to keep the Ghs100 going at its appreciable strength returns on it should be more than the 7.8%. Currently, most pension funds in the country should be returning something higher due to the investment guidelines set out by the National Pensions Regulatory Authority (NPRA).
The Investment Guidelines for Pension Schemes in Ghana
The guidelines permit schemes to invest up to 60% 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 more higher than the regular bank savings would give you. Additionally, the assets are highly regulated. The regulations protects 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 17% per annum which is much higher than the 5-8% offered on a 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 like retirement.
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 look out 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). Additionally the NPRA forbids pension investment into certain types of investments and in some financial institutions. This goes to add an extra layer of protection for pension schemes in Ghana.
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. The savings part would be useful when retirement benefits are paid and one wishes to place a portion in a savings account for easy accessibility to funds. Instead of regular savings for a long-term accumulation of funds the best tool Why Bank Savings is not a Good Retirement Planning Option in Ghana still remains a typical pension scheme like United Pension Trustees’ product called ‘My Own Pension which also has an easy way to contribute through mobile money. In collaboration with MTN, the fund has offered very convenient mobile money avenue to contribute into it.
*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 at October 2019