Friday, April 20, 2007

The other day i noticed quite a number of female aquitances i know are pregnant or have just given birth.It got me thinking about life and specifically old age and retirement.You may NOT believe this but as surely as you are breathing now one day you will be old and living on your pension,income or alms(depending on your state of affairs then).

About Pensions
There are two main pension scheme types:
-Defined Benefit: The employer shoulders any risk in the plan i.e. if at retirement the pension scheme assets havent made sufficient returns, the employer has to fork out the difference.
Forking out the diffefrence leads to a drop in profits.These are the legacy costs that companies like FORD and GM in the states suffer from.

The plus side of these schemes is that the benefits can be enormous(to the workers).Its also hard to value transfers in cases of shifting from one scheme to another.Government of Kenya has such a scheme But it is closed to new workers from July 2006.All new Government workers join a defined Contribution scheme.
Most private employers have shut down such schemes or converted them to defined contribution because of the risk it exposes the employer to.

In this scheme both the employer and employee contribute.But the employer has no further liability other than his contribution.Most new schemes are of this kind and the older schemes are being converted to this.Its easy to value transfers between funds in case of job changes

Why should you care?
Defined benefit schemes with some inflation protection tend to be the best.If you live 20+ years after retirement you can find yourself in a situation where what you earnn as pension is higher than your salary before retirement.The sufferer is your former employer because he has to ensure you get the actuarially set monthly payments whether or NOt the scheme returns are sufficient.

Defined Contribution- You are paid what the scheme assets make.If you have a crappy manager tough luck.Thats why scheme beneficiaries and members have yearly meetings with their managers.You are suppossed to throw out the manager if he isn't performing.

This post covers employed people.I'll do one for the unemployed and self-employed.


MainaT said...

Pesa, defined benefits will be history in Uk/US in the next 20 years. Because of the changes in demographics and just poor invetments combined with International Accounting Standards that require Cos to take a P&L hit every time there is a deficit in the pension fund. Also the fact that cradle-grave typ[e of jobs are no longer mean increased administration. Finally, these days I prefer to get higher pay which I can use to invest as I wish that to have pension (defined contributions) counted as part of my package.

Hoseah said...

Defined benefit used to be a great investment tool because most people used to stay with the same company through their worklife. With the great number of job changes defined contribution makes sense not only for the employer who doesnt have to take on the risk and responsibility but also for the employee who would like to continue their contribution while movin on to another employer. DC also allows the employer to chose which stock, bond, funds etc to invest in as opposed to your employer making that decision for you.

Hoseah said...

DB is one reason why some companies like Ford, and GM are struggling. They have to provide for too many former employers. Many companies like GM, Verizon and IBM froze their pension plans because these DB plans were costing the companies too much. I agree with Mainat, in a few years DB will be history

pesa tu said...

@everyone: I think DB is already history.Tell me where in Kenya u can get a DB package? Even the Government of Kenya closed its Non-contributory DB last year to new entrants.

Ford ,GM and their ilk are paying for the overly generous labour negotiaions in the 1950s and 1960s.Just shows that the future arrives faster than u expect it.

jamvi said...

DB seem like communism a seemingly good idea but impractical I agree with Maina T good pay now for individuals and let them decide what to do with their money. This is a win win situation and we would probably not have the GM fiasco

pesa tu said...

@Jamvi: Thats why DB is dying out,BUT in some places it still makes sense