Poor pension planning can lead to dire financial straits later on in life. So, in trying to secure reasonable comfort in your retirement days, here enters another aspect of insurance you should specifically consider: retirement or pension plans.
First, note that employers’ pension plans are targeted at providing about two-thirds your final salary after about 33 years’ service. This is when the employers’ plan is a defined benefit pension plan. However, companies are moving away from defined benefit plans towards defined contribution plans. This is mainly because a defined benefit plan places the investment risks on the company rather than the employees.
The defined contribution plan identifies and guarantees what the company will pay into the plan and leaves the investment of those funds to the discretion and direction of the employee. Whatever net investment returns are earned during the life of the plan, along with the accumulated contributions, will make up a pool of funds that will then fund the monthly pension on retirement. So the employee’s success or failure in directing how his funds should be invested will determine the size of the pool of funds available to be converted into a pension annuity.
In planning for retirement, the insurance option of purchasing individual retirement plans is therefore becoming more and more important for both employed and self-employed persons. There are two types of plans – the Registered Retirement Saving Plan (RRSP), and the Registered Deferred Annuity (RDA). “Registered” denotes the fact that these plans are regulated by Government and must be registered with the Barbados Revenue Authority. RRSP plans can be purchased through an insurance company or other financial or investments firm like banks, credit unions, investment managers or mutual fund company.
RDA plans are typically purchased through an insurance firm. The investment choices are entirely the responsibility of the insurance firm, and administration fees and commissions may be applicable.
RRSPs and RDAs operate similarly except that with an RRSP, you have some say in how the funds are invested. You make contributions to the plan which, along with the net interest earned over time, provide a pool of funds at maturity. This fund then is used to purchase an annuity which can serve either as your pension or to supplement the pension you may have received from other sources.
These plans are valuable for pension planning as they allow persons to deduct the amounts contributed for taxable income. The rule is that the amount contributed to any one plan and to both plans added together must not exceed the lower of $10 000 or 15 per cent of the assessable income for the income year. So taxpayers can save towards funding their retirement on a tax deferred basis; that is, the eventual flow of funds as a pension will be taxable albeit at a likely lower rate in retirement.
RRSPs have the added benefit of allowing the withdrawal of ten per cent of the purchase price of a first home up to a maximum of $25 000 free of tax. In addition, at maturity, 25 per cent may be withdrawn tax free, leaving the balance to purchase the pension annuity.
There are also a range of insurance products which offer a hybrid of savings towards pensions as well as insurance coverage. The big difference with such plans is all funds contributed are with after tax income and part of the premium has to fund the cost of the insurance coverage.
Retirement planning must take into consideration the individual’s time horizon to retirement and the percentage of final income assessed as needed during retirement because income needed may well exceed the two-thirds customarily offered through corporate pension plans for 33 or more years’ service. Persons need to take a scientific approach in making contributions to RDAs and RRSPs by making a comprehensive needs analysis guided by their financial adviser.
• Louise Fairsave is a personal financial management adviser, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances. This column is sponsored by the Barbados Workers’ Union Co-op Credit Union Ltd.
