The Tribune

By Larry Gibson

Two weeks ago in this column, I wrote: “Recently, the local press carried stories about growing unrest at the Central Bank of the Bahamas. Apparently, management at the Central Bank is trying to restructure pension arrangements so as to ensure a more sustainable plan going forward.

“It was indicated that annual required contributions to the existing defined benefit plan exceeds 20 per cent of payroll. It is said that most, if not all, of the statutory corporations including BEC, Broadcasting Corporation, BAIC and Water & Sewerage Corporation all face massive shortfalls in funded status. The newly-privatised BTC also sits among the pack. In aggregate, this is a situation which is most frightening.”

As a result of penning that column, I was asked by many readers to explain the different types of pension arrangements that exist, as many workers who participate in a plan do not really understand much about their plan or its structure.

Paradox

There is a great paradox that exists for the majority of Bahamian workers. Traditionally, we have always been taught that if you work hard, educate your children to the best of your resources, and save for a rainy day, you will be able to retire and finally enjoy the good life. The paradox is that very few of us will actually realise this elusive dream.

The stark reality is that the vast majority of retirees will actually experience a significant reduction in their standard of living because they simply have not planned for the day when they are no longer able to work.

This applies to the majority of the working population, because in the Bahamas today we have a working population of around 194,000 persons. Of these, it is estimated that less than 40,000 of those workers or about 23 per cent, are covered by a pension plan. This poses a great systemic risk to the country’s future well-being.

What happens to the 77 per cent who do not have a pension plan? The social implications of this situation are enormous. From a policy perspective, this condition cannot go unattended.

What is the purpose of a Pension Plan?

The purpose of a pension plan is to assist in providing a source of income to the elderly, once they have stopped full-time employment or ceased to be in the workforce. By providing a pension plan, our retired workers will have either an income stream or assets that can be converted to cash to provide for living expenses. The theory is that if we can get workers to save for retirement, this would become less of a burden to their families and/or the state.

The more you save or put aside for retirement, the better the standard of living one can expect in retirement.

For the 23 per cent of the population covered by a pension plan - there are two basic types of pension plans.

Defined Benefit Pension Plans (DB Plans)

The civil service, most public corporations and many of the older, established private companies have defined benefit pension plans. A defined benefit plan promises the employee a specific monthly benefit at retirement based on a formula that considers their salary and years of service.

Pure DB plans generally do not require employees to make contributions to the pension fund. However, in an effort to increase the benefits available upon retirement, some DB Plans require that employees also are required to make contributions. The latter is known as hybrid plans.

The advantage of a DB plan is that the employee is promised a fixed rate of pension that is available for one’s lifetime. Also, most DB plans provide for some spousal benefits (at a reduced rate) for the natural life of the spouse.

A typical DB benefit calculation is:

• Average of five years highest earning years times a factor (say 1.5 per cent) times years of service.

• Therefore, for a person whose best five years average $20,000 per year and services equal 30 years – your annual pension would be:

• $20,000 x 1.5 per cent x 30 = $9,000 per year or $750 per month.

Defined Contribution Plans (DC Plans)

Defined contributions plans are the structure of choice for newly-created pension plans. The advantages of a DC plan are that it is simple to understand and its administration is relatively easy, and does not require the services of an actuary.

In a typical structure, employees are required to make monthly contributions via payroll deductions, with the employer matching those contributions up to a certain percentage. Most commonly, the employer would match employee contributions up to a maximum of 5 per cent. Employees are also permitted to make additional voluntary contributions, which are not matched by the employer.

In a DC plan, each participant’s benefits are based solely on the contributions made to the participant’s account. Income or gains are credited to the account, and expenses, losses or forfeitures assigned to a participant’s account are deducted.

Therefore, at retirement, the employee is entitled to the full balance in his account as opposed to a lifetime stream of payments.

• See table provided

Conclusion

For those of you who work for an employer with a pension plan (the 23 per cent), firstly, find out what type of pension plan your employer offers and. second, make sure that you participate.

For the 77 per cent, ask your Member of Parliament what are they doing about this untenable situation?

Until next week…

Tickets now available

Colonial Pensions will be hosting the world renowned, two-time Emmy Award winning financial talk show host, best-selling author and columnist, Suze Orman, on May 17, 2014, at the Melia Cable Beach Resort.

Come and hear what she has to say about ‘personal finances and retirement planning’. Tickets are $35 and can be purchased from Colonial Pension Services, 3rd Floor Atlantic House, and 2nd Terrace & Collins Avenue. Call 502-7526 for full event information.

Until next week…

• NB: Larry R. Gibson, a chartered financial analyst, is vice-president - pensions, Colonial Pensions Services (Bahamas), a wholly-owned subsidiary of Colonial Group International, which owns Atlantic Medical Insurance and is a major shareholder of Security & General Insurance Company in the Bahamas.

The views expressed are those of the author and do not necessarily represent those of Colonial Group International or any of its subsidiary and/or affiliated companies. Please direct any questions or comments to larry.gibson@atlantichouse.com.bs