Oran Hall | All approved retirement schemes are not alike

Approved retirement schemes, often called individual retirement accounts, must operate in a way to meet the requirements of the law and be compliant with the requirements of their regulator, the Financial Services Commission.

As such, they are similar in many ways, but they also differ in their operations in several ways in their quest to gain a competitive edge in the market.

They are sponsored by financial institutions such as banks, credit unions, stockbroking companies and life insurance companies, some of which serve as investment managers and administrators directly or through their subsidiaries.

There are many ways in which these retirement schemes for individuals are similar, many of which are prescribed by law. The following are examples of what is common to them. The contributions of members are invested in pooled investment funds, which are unitised to make it easier and more transparent to determine and see the value of the contributions of the members.

There are no guarantees on investment returns. Contributors are allowed to choose the funds into which their contributions are invested. Members cannot contribute more than 20 per cent of their income to a retirement scheme. Members can switch from one retirement scheme to another.

Additionally, the schemes are defined contribution plans, meaning that benefits are based on the accumulated value of the contributions made by and on behalf of each member and not by a formula as in the case of defined benefit plans. The accumulated value of a member’s contributions cannot be surrendered for cash except at retirement when 25 per cent can be disbursed as a lump sum tax-free. The retirement schemes do not facilitate contributors using their contributions as security for loans or assigning them to another person as the income tax authorities limit how contributions to them can be used.

But there are variations in how they operate. They vary in the minimum sum that an individual can contribute to them on an annual basis, ranging from no minimum sum, to $12,000 per annum paid monthly or annually, to five per cent of an individual’s pensionable pay. Nonetheless, members are allowed to change their minimum level of contribution periodically.

Some schemes allow members to make ad hoc or supplementary contributions as well, in one case the minimum sum being $5,000 and another other $10,000, but they are constrained by the requirement for total contributions not to be in excess of 20 per cent of the member’s annual income.

The retirement schemes facilitate the payment of contributions by many different means, some more than others, the idea being to make it convenient to make the contributions.

RETIREMENT VS DEATH

There is a difference between how benefits are treated at retirement and when a scheme member dies before retiring. At retirement, the standard is for the members to take 25 per cent of the accumulated value of their contributions as a lump sum – the maximum allowed by law – with the balance being used to purchase an annuity to give the retiree a regular stream of income.

On the other hand, there are several ways in which benefits are paid to the beneficiaries of scheme members who die prematurely. For example, in one case, the benefit is a sum equivalent to two times the annual earnings of the late member plus interest credited to the date of payment to the nominated beneficiary. In another, the accumulated value is paid as an annuity to nominated beneficiaries or the legal representatives of the deceased. It seems, though, that the most common option is for the accumulated value of the contributions to be paid to the beneficiaries as a lump sum.

The schemes offer several investment portfolios – some giving far more options than others – with varying levels of risk, and allow members to switch from one fund to another to achieve a reallocation of their portfolio, but the approach differs. Whereas some allow switching between portfolios once per year at no cost to the member, at least one allows two free transfers and one has no limit on free transfers.

Although there is general agreement on the minimum age at which people can begin to make contributions to the pension schemes – 18 years old – the maximum age at which people can become members varies – from 58 to 68 – based on the evidence I have seen.

It is prudent to take time to do research before deciding which approved retirement scheme to select. They have literature which describes what they do and how they do it. Although past performance does not guarantee future performance, it is helpful to know how the investment funds performed over five years or so. It is also important to ask meaningful questions of the individuals who market these products and weigh the information carefully.

Oran A. Hall, author of ‘ Understanding Investments’ and principal author of ‘ The Handbook of Personal Financial Planning’, offers personal financial planning advice and counsel. finviser.jm@gmail.com