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A pensioner outside the Whitfield Town Post Office.
Hopeton Morrison, Contributor
FOR THOSE who have worked all of their lives the decision is often whether to collect a pension in the form of a lump sum payment or to take a series of equal payments commonly referred to as a lifetime annuity. Perhaps the cause of greatest discomfort is the fact that once a retiree commits to one option it is impossible to get out of it.
As one draws close to retirement the factors that invariably come into play are health, income sources, family considerations and perhaps most critically how long you are going to live after retirement.
Here in Jamaica, different plans set their own rules. Different plans for example set different retirement ages with some offering retirement to men and women generally from age 60 to 65. The law of the land however does provide for persons to claim pension benefits from age 55 (by way of early retirement) although actual payments sometimes start later.
COMPARISON
Enlightened employers provide a comparison for retirees to view differences between lump sum payments and a lifetime annuity option notwithstanding the fact that the employee is the one who makes the final decision. Your concern as a pensioner should be driven by the amount you receive, tax considerations if any and how long you will be guaranteed to receive these payments.
It is interesting to note that the origins of pensions were based on the belief that an employer had an obligation to provide for retiring employees who had spent an entire lifetime working for the business. This approach to providing for past employees came to be known as defined benefit plans where employers placed money into different funds to pay a stable income for the remainder of their employees' lives. Concurrent with that plan was the fact that employees were paid based on how long they worked and how much they earned during those working years.
But increasingly the trend worldwide has been to move towards Defined Contribution Plans where the employer invests an agreed amount into a pension investment without a guarantee to employees of their returns. Consequently their pensions on retirement could be considerably larger or correspondingly smaller depending of course on how well funds are managed.
While there is no generally accepted right way to take a pension payout, it comes down to measuring the advantages and disadvantages of each method. If, for example, you chose to take a lump sum payment one assumes that you are very comfortable with investing this money and/or you have a very competent investment advisory team. The latter is not hard to find in Jamaica these days as there are numerous brokerages, banks, credit unions, merchant banks, investment houses, and other financial institutions most of which are staffed by highly qualified persons to advise you on the most effective investment decision. Such a decision is also helped considerably if you have been a successful investor prior to this pension payout. In truth a lump sum payment at that time in your investment life could be the best thing for your portfolio's health and longer term profitability.
The challenge of retirement is always how best to get your money to work for you. But there are many of us who are less risk oriented and prefer the relative safety of collecting a set amount each month via the lifetime annuity method. Such an approach allows you to budget realistically at least in the short term. The big problem here, of course, is the real threat of that most voracious of all taxes, inflation.
LUMP SUM PAYMENT
Generally speaking, the big advantage of a lump sum payment is that you can put this fund to work for you immediately and gain almost exponentially on your returns as long as you are investing. The disadvantages are that you could spend it faster than it can generate a positive return because of a myriad of unfortunate events such as the serious illness of a close family member, or the occurrence of disastrous to catastrophic acts of man or God for example. One not so unusual problem commonly occurs where you are given poor investment advice by persons who you really have no business taking this advice from in the first place. So called "financial experts" in your family are good for general advice but you are probably better off seeking paid, professional, independent advice on this front. Yet another problem here is that you could leave yourself and your spouse out on a very thin and dry limb because you have closed the door on a steady source of monthly income. Where annuities are concerned, the advantages here are quite obvious.
You have some confidence in the fact that your payments are assured hopefully for the rest of your and your spouse's life. In addition, your payments are coming to you monthly or however you decide to have it paid. You can make your budget based on that. The disadvantages here are not always so obvious however. Because your annuity is not indexed to the rate of inflation, you are paying a very heavy tax here especially where the inflation rate enters double digits or approach very high levels.
We have experienced these levels in the past. In the years 1978, 1979 and 1980 annual inflation rose to 49.4 per cent, 19.4 per cent and 29 per cent respectively. It got much worse between 1989 and 1996 when average annual inflation for those eight years was 33.21 per cent with the years 1992 and 1993 being exceptionally brutal with rates of 80.2 per cent and 40.20 per cent respectively. You may recall that in those years however, there was some alleviation of sorts with deposit rates climbing to well over 50 per cent.
A very real and present danger is that traditional pension plans (defined benefits plans) are becoming unstuck worldwide. Many plans are now underfunded and in great danger of collapse. Under funding has been caused by the fact that many retirees are living well beyond the ages determined by actuaries when these funds were first established.
At the turn of the century persons rarely lived beyond their 70s. Today many lead very active lives into their 80s and 90s. All over the world and right here in Jamaica persons are living for a considerably longer time. In fact, it is widely acknowledged now that pensions especially in the more developed countries (including the Unites States) are in crisis and this warning has come from no less a source than the world's most important economist, Alan Greenspan himself, chairman of the Federal Reserve Board in America (the equivalent of our Central Bank governor).
THIRD OPTION
There is a however, a third option, which local actuaries and consultants advise us is to be provided under the proposed new pension plan now in the final stages of the legislative process. This would be the equivalent of what the Americans refer to as Individual Retirement Accounts (IRAs). These accounts, if the legislation passes, will allow pensioners to invest a greater portion of their income (up from the present 10 per cent voluntary contributions) to 20 per cent into their own individual retirement accounts.
With this increased threshold on investments persons will be able to maximise even more their tax-free benefits. When an IRA benefit is combined with the tax-free benefits now generously offered on local equities and nearly all of our locally-based unit trusts and mutual funds the long-term financial benefits for the pensioner will now take on vastly improved terms. Allied to this is the fact that the new regulations propose to give these plans portability, that is allow employees the ability to move among different employers with their pension plans.
Indeed, the possibilities are looking quite lucrative for the shrewd investors among the new generation of Jamaican and Caribbean employees what with the soon to be approved CARICOM Single Market and Economy.
Hopeton Morrison is general manager of St. Thomas Co-operative Credit Union Ltd. and lecturer in the School of Business Administration at the University of Technology. E-mail: hmorrison@stccu.com
