Lecture notes on Pensions

Definition: A pension is a fund into which a sum of money is added during an employee’s employment years, and from which payments are drawn to support the person’s retirement from work in the form of periodic payments. A pension may be a ”defined benefit plan” where a fixed sum is paid regularly to a person or a “defined contribution plan” under which a fixed sum is invested and then becomes available at retirement age. Pensions should not be confused with severance pay; the former is usually paid after retirement, while the latter is typically paid as a fixed amount after involuntary termination of employment prior to retirement.

Types of Pensions

(a) Employment based pensions – This is a retirement plan to provide people with an income during their retirement from work. Often retirement plans require both the employer and employee to contribute money to a fund during their employment, in order to receive defined benefits upon retirement. It is a tax deferred savings vehicle that allows for the tax-free accumulation of a fund for later use as a retirement income.

(b) Social and state pensions – Many countries have created funds for their citizens and residents to provide income when they retire (or in some cases become disabled). Typically this requires payments throughout the citizens working life in order to qualify for benefits later on. A basic state pension is a ‘contribution based benefit’, and depends on an individual’s contribution history. For example, National Insurance contributions in the United Kingdom.

(c) Disability pensions – Some pension plans will provide for members in the event that that they suffer a disability. This may take the form of early entry into a retirement plan for a disabled member below the normal retirement age.

Pensions in Nigeria

In Nigeria, the Pension Reform Act 2014 (PRA) governs the framework and procedure for pensions. The Act repeals the Pension Reform Act No 2 2004 and enacts the Pension Reform Act 2014 to continue to govern and regulate the administration of the uniform contributory pension scheme for both public and private sectors in Nigeria.

Challenges of pensions in Nigeria for individuals

The problem with pensions in Nigeria is that Nigerian workers are not preparing for retirement. A pension is a retirement account where employers and employees make monthly contributions. In Nigeria, employers contribute 10% of the salary and the employee contributes 8%. This is known as the contribution scheme. The money goes into what is known as the Retirement Savings Account.

Who is entitled to a pension plan?

Workers in the public sector
A worker in a private company with over 15 workers makes the contributions mandatory.
Workers in a private company with less than 3 workers (or self-employed workers) are entitled to participate in the scheme subject to Pension Commission guidelines.
The law is however silent on a worker in a private company with more than 3 workers and less than 15 workers.

How are pensions managed in Nigeria?

The Pension Reform Act 2014 (PRA) established a body called the National Pension Commission (NPC). The main function of the NPC is to enforce and administer the pension regulations as laid down by the PRA 2014. It regulates 2 types of companies;

The Pension Fund Administrators (PFAs)
The Pension Fund Custodian (PFCs)

The employee is meant to choose a PFA to manage his/her pension. There are a number of registered PFA’s in Nigeria and so the employee has a variety of choices to make. Once the employee has made a choice, he/she then has to inform the employer.

The pension contributions are then deducted from the employee’s salary and are paid to the PFC specified by the PFA. The PFC upon receipt of the contribution then informs the PFA of receipt of the funds and the PFA then credits the Retirement Savings Account of the employee.

If the employee changes jobs, the law provides that the employee can keep his/her account with the PFA, if he/she so wishes. However, they can change PFA’s but restricted to not more than once in a year.

What happens to pension contributions when they are deducted from an employee’s salary?

The PFA take the funds and invest them in certain approved investments e.g. government bonds, bill and other securities, shares of public limited companies, real estate development investments. This is strictly monitored by the Pension Fund Commission with substantial fines and penalties for erring PFA’s.

How are pensions accessed?

Employees are not allowed to access the Retirement Savings Account until they retire or attain the age of 50 years (whichever is later). The 50 year/retirement rule is a general one. However, there are exceptions to the rule, if the person leaves employment before age 50 for medical reasons or in accordance with the terms and conditions if his/her employment which allow for partial lump sum removal in certain circumstances.

Upon retirement, the individual is able to utilise the amount credited to his retirement savings account for the following benefits;

Withdraw a lump sum from the total amount, provided that the amount left after the lump sum withdrawal is sufficient to procure a programmed fund withdrawals or annuity for life.
Programmed monthly or quarterly withdrawals calculated on the basis of an expected life span.
Annuity for life purchased from a life insurance company.

What happens to employers who do not remit?

It is mandatory for your employer to remit the pension contributions and any non-remittance or late remittance is illegal. The penalty is payment of the amounts which are due to be paid back plus not less than 2% of the amount due.

Advantages of contributing to the pension fund

The employee does not need to worry about retirement plans as a pension is basically a long term savings plan with tax relief.
Regular contributions are invested so that they grow throughout the employees career and then provide him/her with an income in retirement.
In a country that does not have a welfare state, pensions will go a long way in catering for the employee during his/her retirement years.
Death and old age are inevitable and so the beneficiaries of an employee have something to fall back on, when the latter dies unexpectedly or cannot work any longer due to medical reasons.
A supplemental pension plan is part of the fringe benefits that an employer can offer his employees. The employer will therefore make it easier to attract and keep competent employees.
Pension contributions provide both employers and employees with a way to reduce current income taxes by making pre-tax contributions into a retirement investment account. Contributions grow tax-deferred until withdrawal.
A pension will in the long run help the retired employee to maintain a middle class standard of living and retirement savings provides important supplementary income for unforeseen expenses.

Registered Pension Fund Administrators in Nigeria