OPINION: Not every investment can be a pension

It has become necessary to write on this subject due to the numerous feedback on the options people consider as their pension. The various options include existing business, reliance on investment vehicles like equities, bank savings and even children.

This edition looks at the downsides of fund accumulation using a bank savings as an option. Remember that no option is bad in itself, but the failure to identify and mitigate the risks those options are exposed to may eventually render them ineffective.

What is the difference between a pension fund and a regular bank savings?

That is where the downside of using bank savings as a retirement income resides. Funds in savings would be 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.

In this case the risk of benefit shortfall would mostly arise from administrative and data management lapses.

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 remotely involved with SSNIT, benefits are assured. This 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.

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.

It means 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.

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 trustees and fund manager.

The fund managers usually invest the funds for returns generally higher than inflation. Under accumulation of funds we know that if we 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 GhC100 strong is to invest and earn some returns. A better way however, is to invest the GhC100 and make returns higher than inflation. Currently Ghana’s inflation rate is 11.8% so to keep the GhC100 going at its appreciable strength; returns on it should be more than the 11.8%. 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 guidelines permit schemes to invest up to 60% of the funds in Treasury instruments and 20% in equities (shares of organisations). A good combination of these as well as other permitted asset classes in pension fund management is expected to yield a higher return than the regular bank savings would give you.

Also being a pension fund, the assets are highly regulated. The regulations protect the fund from unnecessarily high risk investments and caps services charges to reasonable levels. Such provisions add greater value to pension schemes and monetary benefits become tangible over the medium to long term. With a good management, a typical pension scheme could yield anything from 23% per annum which is much higher than the 8-12% to be offered on a typical savings at the bank.

Regular bank savings have a role they play in accomplishing other financial objectives but definitely not when accumulating funds for long term life objectives such as retirement. 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, you can additionally join an extra 3rd tier to contribute more (if there is still an allowance on your 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 funds.

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 may come in handy when retirement benefits are paid and one wishes to place a portion in a savings account for ease of accessibility for drawdowns. Instead of regular savings for a long term accumulation of funds the best tool in financial planning still remains a typical pension scheme with more attractive returns rates (much higher than inflation), with the benefit of tax incentives. And who wouldn’t want to save on tax?

*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 January 2018

The author is a Pensions and Management Consultant with M-DoZ Consulting. He provides retirement planning and pension advisory services to organisations and groups.