What about Retirement

Hybrid pension schemes, which blend the advantages of defined Benefit and Money Purchase schemes, are good alternatives for keeping the pension promise. However, despite their flexibility, they are hardly ever considered by firms.

Apart from providing an effective means of attracting and retaining good staff, an employer sponsored retirement arrangement sends a signal to employees that the employer is with them for the "long hall." There is also the moral argument that employers should provide a satisfactory level of income security in old age to reward long service employees. Of course, if the reward is considered reasonable it will encourage employees to stay in service.

From an employer's perspective, it provides an opportunity to take advantage of available tax concessions and increase profits. From an employee's perspective, any pension received (together with personal assets), should enable him to maintain his pre-retirement standard of living and protect his dependents.

The fiscal benefits of planning for future retirement should be fully explored before a person or company agrees to joining or setting up a pension plan. Two of the most important conditions for tax concessions for occupational pension schemes is that the plan must be set up under Trust, and, it must be approved by the Board of Inland Revenue.

The Trust ensures that it is impossible for the employer to divert contributions before the satisfaction of all the plan's liabilities. Additionally, the employer must contribute to the plan. In Trinidad and Tobago, employee contributions are not necessary to gain the Inland Revenue's approval. However, most pension plans are contributory. Tax concessions also encourage pension plans.

Income tax relief for contributions to all approved plans is available on up to 1/6th of an individual's annual assessable income. The pension paid is taxed as income and there is a statutory maximum of 2/3rds the highest salary on the amount that can be paid. Up to 25% of the pension can be converted into a tax- free lump sum on retirement.

Final Salary Plans

In Trinidad, the majority of the plans are defined as benefit schemes, with final salary type plans being the most prevalent. In a defined benefits arrangement, benefits are specified in the plan rules and are usually directly related to salary.

In a final salary scheme, pensions are based on salary at or near retirement and calculated on length of service. Since the benefits are guaranteed, the employer bears the risks(rewards) of unfavourable(favourable) asset performance. Contribution rates can vary, but are usually lower in the long term than other forms of pension plans.

Administration expenses and contribution rate volatility decrease as the size of the plans membership increases. For a large employer who wants to direct resources to particular groups of employees, a final salary plan may be appropriate.

Money Purchase Plans

Money purchase or defined contribution plans are relatively uncommon in Trinidad and Tobago. In these plans the pension benefits are not guaranteed. Each member of the plan has a separate account where his contributions and those of the employer (on his behalf) are accumulated. The benefits payable to each member depend on the contributions paid by him and/or on his behalf, allowing for interest credited and expenses deducted. Plan members therefore, bear the risk(rewards) of poor(good) investment performance. For a small plan, administration, which involves monitoring members accounts, can be relatively cheap.

Benefits for early leavers tend to be higher than in final salary plans, and more easily quantifiable. This is because the early leaver's account will grow with interest and therefore provide a real benefit on retirement. In a final salary plan however, the early leaver benefit would usually be based on salary at departure and consequently not be adjusted for inflation.

Non- traditional Options

For the employer who wishes to provide pension benefits without setting up an occupational scheme, there are many options. These include bank retirement income products, insurance company deferred annuities, and Section 134(6) plans.

Deferred Annuity Products: Both the banks and insurance companies deferred annuities are money purchase in nature. Currently, they afford the employee tax relief on contributions up to 1/6th of assessable income. However, the employer's contributions will have to be made indirectly, since the contract is made between the bank/ insurance company and the employee and is owned by the employee. The employer can agree to fund a retirement benefit for his employees as long as employer contributions are placed in an individual retirement account of the employees choosing. The company can then contribute on behalf of its employees to either of these approved plans by granting an increase in salary which is deducted at source, and remitted to the appropriate financial institution. The amounts transferred would represent salary expenses for the employer and a retirement contribution for the employee.

Portable funds

Since the contracts are owned by the employee, they are completely portable. This means the individual can maintain his contributions if he changes jobs, unlike a traditional employer sponsored money purchase pension plan. Holders of these contracts must be between ages 50 and 70 to purchase annuities. There is no 2/3rds salary limit on the amount that can be paid as a pension.

Bank retirement accounts are subject to 15% tax on earned interest, unlike insurance company deferred annuity accounts, which do not attract tax on interest. On maturity of the bank contract, 25% of the total amount contributed, plus all interest earned can be taken as a tax free lump sum. This can be a large proportion of the final fund. Twenty five percent of the total fund accumulated under an insurance company deferred annuity contract can be taken as a tax free lump sum. In both cases, income tax is payable on the annuity purchased by the residual fund. Section 134 (6) Plans: An amendment to Section 134 (6) of the Income Tax Act allows companies to contribute to any insurance contracts, except group life, specifically for pension provision.

These will be approved by the tax authorities as long as:

• the total of employer and employee contributions to the 134 (6) contract, and employee contributions to any other approved pension plan or deferred annuity contract, does not exceed 1/3rd of the employee's chargeable income;
• the proceeds of the contract are paid in the form of a pension;
• payment on maturity of the contract does not occur before age 50;
• the lump sum on maturity does not exceed 25% of the fund.

Therefore, these contracts are owned by the employer and are not portable. Employer contributions are treated as business expenses and are used to reduce his tax liability. In this case the employee's contributions are made indirectly. For example, an employer can offer to pay $100 per month into a Section 134 (6) contract on behalf of an employee rather than give the employee a $100 salary increase. Unregistered Annuities: Situations may arise where contributions paid by an employee equal the maximum allowable by the tax authorities for tax relief. Additional contributions can be made to an unregistered annuity. No income tax is currently charged on pensions paid by such annuities.

Alternatives

Hybrid schemes, which blend together the advantages of defined benefits and money purchase schemes, are alternative means of keeping the pension promise. These can be tailored to the changing employment patterns within a company. For example, instead of continuing with a final salary plan which offers benefits based on 2% of final salary for each year of service, a company could decrease the accrual rate to 1% and add a money purchase type section.

This money purchase section can be of the traditional type or any of the non traditional options we have discussed. This could control costs and represent a reasonable sharing of investment risk. Contributions to the money purchase section could be varied depending on the member's age. Additional contributions to the money purchase section can be made depending on the company's profitability each year. Alternatively, a pure money purchase arrangement for younger employees with a switch to a final salary plan for older members may better meet employees needs.

For larger employers, arguments favour final salary schemes, while for some small employers, the disadvantages of final salary schemes can be overwhelming. Money purchase plans are more suited to smaller firms, and those where staff turnover is likely to be high, or when the employer wants employees to share in the investment risk. Ultimately, the pension provision arrangement chosen by an employer should be driven by corporate objectives. It is often possible to reduce costs and yet provide a better benefit. Companies have to make decisions which best suit their business with respect to control, certainty of costs and attracting and retaining good staff.

Shelley Worrell is an actuarial analyst with Acumen Limited, Actuaries and Benefit Consultants, a member of the Buck Consulting Group of Companies. She holds a first class honours degree from the University of the West Indies in Economics and Mathematics, an M.Sc. in Actuarial Science with distinction from City University, London and the Certificate in Actuarial Techniques from the Institute of Actuaries.