Why Pensions Are Important!

Intro

The Earlier You Start to Save, the Better Off You Will Be on Retirement!

If you had $50,000 today and and added $5,000 at the beginning of each year to an account earning the average rate of inflation of 4%, in 30 years you would have $442,000 dollars. If you invested in stocks (for example) and earned at a rate of 15% you would have $5.4 Million Dollars. Over time your interest is compounded which means that the value accumulates as I explained in my article Is Your Savings Beating Inflation. But is $442,000 OR even $5.4 Million enough to save up for when you can no longer work? You don’t know for sure because you don’t know how much longer you will live, but if you have pension savings, you are guaranteed a certain income for the rest of your life, based on amounts that you have saved leading up to your retirement.   

 If you work for an organization that has a pension plan, your employer will deduct pension payments from your salary and place it in a fund that earns interest for you. Usually for a regular savings account you must pay the government tax on any interest you earn, but pension funds are a special savings vehicle that you can earn interest tax free!

The interest that this fund earns at is usually higher than the rates paid out by banks (also explained in Is Your Savings Beating Inflation) and should typically earn more than inflation so that you have enough money to replace your current income when you are no longer working.

 Why is it best to start paying pension from you are younger? The answer – compound interest. Compound interest is an effect that multiplies your savings balance by (1+ interest rate) each year.

Year 0 = $50,000

Year 1 = $50,000 *(1+0.04) = $52,000

Year 2 = $52,500*(1+0.04) = $54,080  … etc.

That rate is what makes the difference between earning $442,000 versus $5.4 Million.

So why does that matter? When you retire, you will no longer be earning a regular income, if you don’t own your own business or haven’t invested in another way to make money on retirement (like rental income). Imagine if your expenses when you are 60 are $200,000 or even $500,000 a month and you did not invest/save enough in your earlier years to cover these expenses in your future? Your NIS payments may help, but the benefit is currently $3,400 per week or $13,600 per month[1]. Most persons who are currently contributing NIS payments (at a current rate of 2.75% for employee and 2.75% for employer up to a maximum of $1.5 Million) would not be able to sustain their current lifestyle with NIS income because it is lower than minimum wage.

It is best to put away extra savings or invest in an appreciating asset like real estate to be able to sustain your current lifestyle when you can no longer work. Employers will designate how much of your salary you are allowed to pay as pension savings. They will also sometimes match this amount or match a certain % (e.g. you contribute 10% and your employer contributes 5%). The pension fund manager should also give you a statement of how much is in your account each year. 

When you reach retirement age, an actuary will use the amount you’ve accumulated in your pension savings to calculate how much you can be paid on a monthly basis. When you compare that to your last income, that ratio is called your replacement ratio i.e. how much of your salary is being replaced by your pension benefit.

So back to the $50,000 example. If you add $5,000 a year each year and you started early so you have 30 years worth of savings, and your pension fund manager has done a great job of investing your funds and you are earning 15%, then at the end of the 30 years you would have approximately $5.4 million. What if you live for 10 more years? or 20 more years…or 30 more years? Is that enough?

 10 More Years = $45,000 a month

20 More Years = $22,500 a month

30 More Years = $15,000 a month 

Whether or not that will be enough to replace what you were making before you retire YOU DON”T KNOW HOW MUCH LONGER YOU WILL LIVE. If you have a pension benefit, an Actuary will calculate something called your Expected Future Lifetime, they will consider the future interest rates (among other things) and then give you a guaranteed payment for the rest of your life so that you do not have to worry about the money running out before you die.  

So if you do not plan to invest in other ways to guarantee your income, at least put a little a side in a pension fund, which you can sign up to whether or not your employer has their own plan. Speak to an Investment Advisor about doing this. 

Visit this savings calculator to estimate how much you will save in the next 30 years if you start now! https://bit.ly/2kBtJ6C

 [1] http://jamaica-gleaner.com/article/news/20180627/nis-old-age-pension-increased-2800-3400-week

[2] https://www.jamaicatax.gov.jm/documents/10181/106865/payroll_and_contribution_rates_employers.pdf/4ddb3ffd-597b-4fa4-a17c-bde7968ac738