Dear Investor: How Do Occupational Pension Schemes Work?

Finally, you get confirmed as a permanent employee after a 1-year internship at your dream workplace. You hurriedly scan through the contract’s contents happy to see the words “Permanent and Pensionable” and cannot wait to call your family or friends and inform them of the good news. But what does that word pensionable mean? And what exactly are the modalities around it?

Occupational Pension Schemes are schemes whereby only members of staff of a particular employer may join. Employees are hereby the active members of the scheme as they are actively contributing. Once an employee leaves the employer, they become deferred members – meaning they can no longer contribute but their pension benefits remain in the scheme.

In this article, we shall focus on the occupational schemes that fall under the category of Defined Contributions (DC) Schemes as these have become the most popular market preference in Kenya. In DC schemes, members’ and employer’s contributions are fixed/defined either as a percentage of pensionable earnings or as a shilling amount.

However, members have the freedom to contribute more than the defined rate – Additional Voluntary Contribution. An example is an occupation scheme X requiring employees to contribute 5% of their salary with the employer making a similar contribution of 5% of each employee’s salary towards their pension accounts.

Formation and Governance Structure

An occupational scheme may either be a stand-alone scheme or be part of an umbrella scheme. As a stand-alone scheme, the employer is termed as the Founder of the scheme; the firm registers the scheme with the Retirement Benefits Authority and appoints various service providers. These providers include:

Trustees – Oversees that the scheme’s activities comply with the governing law and ensures good governance practices are maintained

Administrator – appointed under an instrument by Trustee to manage the administrative affairs of the Scheme

Fund Manager – Implements the Investment Policy established by the Trustees

Custodian – Hold all assets of the scheme

The process of starting and running a stand-alone scheme is viewed as hectic as it requires a lot of administrative work. Many small and medium-sized companies do not prefer stand-alone schemes. To cure this, such companies join an umbrella scheme that accommodates multiple unrelated employers to join the scheme.

The joining process is easier, more convenient and the work of maintaining the scheme’s activities is taken off the hands of the employers. All that is required is remittance. These umbrella schemes are usually up and running schemes which are also registered by the Retirement Benefits Authority.

Before joining an umbrella scheme, an employer is required to sign a Deed of Adherence or Special Rules that bind it to adhere to the rules of the umbrella scheme. It is possible to convert from a stand-alone scheme and join an umbrella scheme and to leave an umbrella scheme and start a stand-alone scheme.

Contributions

Contributions in occupational pension schemes are compulsory, expressed as a percentage, and are usually remitted by both the employees and the employers. The percentages may vary; in many cases, the percentage remitted by the employee is matched by the employer but this is not a rule and it defers from one scheme to another. Employee’s contributions are made through salary deductions.

Benefits

There are various benefits associated with an occupational retirement benefits scheme and these include:

Every working employee who contributes a portion of their monthly income towards retirement to a registered retirement benefits scheme is entitled to a maximum tax-free contribution of Kshs 20,000 or 30% of their monthly salary, whichever is less. This tax benefits flow over to the employer if not fully utilized by the employee.

If the employer is part of an umbrella scheme then there is of set up as they are joining an already well-governed scheme.

The employees can assign up to 60% of their accumulated retirement savings towards guaranteeing a mortgage facility

The employees can purchase a residential house with a portion of their retirement savings

Leaving Current Employer

As mentioned earlier, when an eligible employee of an organization with an occupational scheme ceases to be a member of staff, they also stop being an active contributor. They automatically become deferred members and at this point, they have three options:

Access benefits – The former staff may choose to access the maximum of 100% of their own portion plus 50% of the employer portion and leave the rest in the scheme. The remaining 50% of the employer’s portion may be accessed at retirement

Transfer benefits – The former staff may choose to transfer all or the part that is left of their retirement benefits to another pension scheme; either a personal scheme or the new employer’s occupational scheme.

Retain benefits – The former staff may choose to retain all of their pension benefits in the previous employer’s scheme. Any funds that remain in the occupational scheme of a former employer continue to be treated normally and earns investment returns.

At withdrawal, one is entitled to receive tax-free lump sum payment from the scheme of Kshs. 60,000 for every full year of membership in the scheme up to a maximum of Kshs. 600,000. The excess amounts are taxed according to banded rates depending on how many years you were a member of any registered pension schemes.

Retirement

The early retirement age in Kenya is 50 years old with the normal retirement age being 60 years. Upon retirement, the benefits in an occupational scheme may either be accessed wholly as a lump sum at retirement (provident) or partial lump sum and partly periodic income (pension).

In the case of a stand-alone scheme, the employer chooses on behalf of its employees which of the two options will apply. This is the case in an umbrella scheme although this may vary as some umbrella schemes may lack that flexibility.

For the pension option, before 65yrs, the annual tax-free pension is Kshs. 300,000 (Kshs 25,000 per month). For lump-sum payments at retirement, the first Kshs. 600,000 lump sum commuted from a registered retirement scheme is tax-free – the rest is taxed in a banded manner. Pensions and lump sum payments after age 65 are tax-free.

In conclusion, being part of an occupational scheme affords two key benefits to an employee: one, tax relief on contributions is enjoyed at source, and two, the employer contributes towards your retirement income. It is not mandatory for an employer to provide a pension scheme and in the event that your employer does not, then you can still secure your future through personal retirement benefits schemes.

READ: This is Why You Should Start Saving for Retirement Now