Q&A-Where do your pension fund contributions go?

Q: I’ve always wondered where the money goes when the company makes deductions from your salary to go towards a ‘pension fund’.  I’m told by some folks that it is now less lucrative than before to put money on government paper than before. What does this mean for pension funds generally?  Are pension funds in Jamaica in trouble?

Ans:The objective of this answer is to provide you with a holistic view of how contributions from an Employer and where applicable, Employee’s or Plan Members, as they are commonly referred to in such plans, are invested in Jamaica’s Approved Retirement Savings plans: Superannuation Funds and Retirement Schemes.  Therefore, to answer your question, there is need to take into consideration the following: (1) how your deductions from your salary to an Approved Superannuation Fund are addressed in the Income Tax Act 1955; (2) the general principles of investing and (3) the current laws of Jamaica which address the investment of contributions to these Approved Retirement Savings plans.  

            Your contributions to an Approved Retirement Savings plan: One of the major problems faced by all nations in our global village is that of how to holistically address the potential poverty issues of the most vulnerable persons in the society.  These persons have been recognized as the young i.e. individuals below say age 18 or 21, the disabled and the elderly.  Hence, as you will observe in Jamaica, there are social programmes that address these needs of the society.  However, no government can address all the needs as they arise.  Hence, it is prudent for the government of Jamaica, like most of its counterparts in the world, to provide incentives to employed persons to save for their retirement: disability, old age and upon death, a benefit to heirs.  In Jamaica this incentive is provided through the Income Tax Act 1955 section 13 and as per Amendment dated 4^th March 2008 section 3.  These sections of the Act seek to provide for tax-deductible and tax-deferred contributions to any Employee who is a Member of an Approved Retirement Savings Plan.

For the tax-deductible benefit, the Act states that where you make contributions from your income, which is no more than ten percent (10%) of your gross income, this amount must be deducted first before tax is applied to your income.  For example, if you earn $100,000 per month; as a Member of an Approved Superannuation Fund (ASF) you take advantage of the maximum 10% contribution of your Pensionable Salary, as stated in the Plan’s Rules; your 10% will be deducted before tax is applied i.e. instead of paying 25% tax on $100,000 you will pay 25% tax on $90,000 ($100,000 – (10% of $100,000 = $10,000).  This is a savings benefit you would not obtain from any other type of savings plan as you are being allowed to legally save a whole dollar rather than those dollars from your net after-tax dollars. 

For the tax-deferred benefit, the Act requires that when you are being paid a benefit as a result of disability and old age, the income is subject to tax where it (income) is in excess of the threshold for persons who are receiving a pension.  For 2011, the income threshold for persons who are in receipt of a pension and over age 65, the annual allowance before tax is deducted from the pension payment is $4……………….  As stated previously, this does not happen only in Jamaica but in most countries around the world.

The general principles of investing: For many of us we believe that everyone is eligible to be an investor as opposed to a saver.  All investments carry with it the risks of gain and loss.  Where the returns are high the loss is equally high and where the returns are low the loss is relatively low.  Due to these risk elements in all investments it is advisable that you complete a Risk Profile Assessment, which will help you to determine what types of investments you could select for your portfolio.  Each type of investment offered in the marketplace has a risk profile of low, medium or high.  Hence, you would be wise to select an asset that matches your risk profile: low, medium or high.  When you know your risk profile, then you are better able to ask the right question when someone is offering you an investment opportunity.  So your question could be ‘What is the risk profile of the investment being offered?’  If the response from the professional is that it is medium and your profile is medium then this may provide a guide to you that the investment has medium loss and medium gain.  But if your profile is medium but in your mind you don’t like to take risk then you can refuse the offer and go for a low risk investment.  Another factor to consider about investing is whether or not your initial approach should be to review your Guaranteed Lifetime Income (GLI) security needs.   If you are a Member of an Approved Retirement Savings plan this provides a base for your GLI and therefore may provide some latitude for you to take on some additional risk whether it is low medium or high.  Hence, based on your situation it may be best to consider maximizing your contributions to your Superannuation Fund plan being offered by your Employer since this provides a safety net for your GLI which you will need as a result of retirement: disability, old age and upon death.  Therefore, as you continue to achieve more GLI, which is close to your income needs to meet your lifestyle expenses, the more you should be open to investing in a diversified portfolio.  Having a diversified portfolio of assets, which are at different risk profiles, is also important.  This helps you to balance out any losses that may occur to any of your investments at any time, no matter how safe and secure they may be at the time of purchasing.  There are many lessons learnt from the past 10 years with regards to investing versus risk taking.  Hence, it is advisable to secure your foundation investments which will provide that GLI when needed most.

The current laws of Jamaica which address the investment of contributions to these Approved Retirement Savings plans: While the Income Tax Act 1955 provides for the contributions to an Approved retirement Savings plan, the Pensions (Superannuation Funds and Retirement Schemes) Act 2004 and the enabling Regulations (Investments) 2006 provides the framework within which the Trustees of Superannuation Funds and Retirement Schemes must use as their guide when investing the Members contributions.  Sometimes we forget that Superannuation Funds and Retirement Schemes contributions are governed by legislation and that they are also monitored by the Financial Services Commission (FSC): www.fscjamaica.org. 

The Act requires annual reporting and all the providers who are offering services for these plans along with the trustees must be registered with the FSC.  This should provide a level of confidence for each Member of these plans but such confidence should not be replaced with complacency.  Therefore, Members should ensure that there are annual members meetings where matters such as how the contributions are invested and whether the Trustees’ investment is being guided by a Statement of Investment Policies and Principles (SIPP) – see section 8 of the Regulations (Investment) 2006.  Section 3(2)(a) of the Regulations (Investment) 2006 addresses the Duties of trustees, investment managers and it states: In the performance of their duties trustees and investment managers shall- (a) determine whether an investment will be able to provide an adequate return at an acceptable risk so that the fund or scheme can achieve its stated objectives.  What is the overall stated objective that is required in any Fund’s Trust Deed and Rules or Scheme’s Master Trust Deed?  It is that of providing an income as a result of disability, old age and death.  Where a fund or scheme does not provide for this objective it will not be approved and the tax-deductible benefits for both the Employer and the Employee contributions will not be available.  This legislation makes great reading and all Plan Members of a Fund or a Scheme should be encouraged to purchase a copy or view online at the ministry of justice website.

Although there is guidance in the various legislations, this does not mean that extraordinary events cannot occur in the marketplace that may jeopardize a desired investment’s return in the short term.  Keep in mind that all approved funds and schemes are there for the long-term and therefore there will be times when some investment returns will be lower than expected.  It is not in those extreme times of volatility which the law is harsh on the trustees but for day-to-day prudence in asset allocation.  Who could have predicted that Haiti and Japan would have had the destruction which they have suffered and which may global markets?  No one could have had an accurate prediction on these events.  In the same way no one could have predicted or envisaged 10 years ago that the JDX would have to be effected due to current global investment trends.  The investment market thrives on high and lows and knockouts.  But those who have a long-term view for building their GLI usually prevail and the objective of the fund or scheme realized.

To address your concerns regarding Jamaica government paper and whether pension funds are in trouble the following points are being submitted for your consideration.  It is expected that you in your community and other readers will use this submission to engage in meaningful discussion on this subject and to use the foregoing points to familiarise yourselves with Jamaica’s Pensions legislations.  Government paper:  Today government paper in Jamaica is not as lucrative as say 5 or 10 years ago.  However, it is still a classified as a low risk type of investment, which should be a part of a portfolio.  In this category of government paper, trustees of pension funds and schemes can decide to diversify and invest in government paper of foreign countries.  The Act provides for overseas investments in recognized stock exchanges in London, New York, etc, hence the trustees can diversify their portfolio in other jurisdictions as allowed under the Act.  Are Jamaican Pensions funds in trouble? This is highly unlikely where the contributions are invested in a diversified mix of assets that meet the criteria laid down in the legislation.  However, as stated previously, this is still not a time for either Trustees or Members to be complacent.   With current global events occurring at a rapid rate there’s greater need for everyone to be vigilant in terms of the risks associated with assets and the objective of preserving each Member’s contributions to provide a meaningful GLI as a result of retirement.

Disclaimer: The information stated above to answer your question is not a guarantee that you will achieve your desired retirement financial and lifestyle goals.  More information is required to provide a more robust response to your personal and family situation.  Readers who are seeking a comprehensive retirement financial and lifestyle advice should do so from a Financial Services Commission (FSC) licensed and qualified advisor who specialises in retirement financial and lifestyle planning.