Pensions: the less you contribute, the less you will get on retirement!
The Sunday Nation
Nairobi,
10 July 2022
James Kariuki asked
me a very short question: “Why does the NSSF (National Social Security
Fund) pay such little amounts to pensioners?” My answer was equally
short: “Because workers contribute very little to the fund”.
I think Kariuki’s
concern arises from the fact that NSSF has funds running into billions
of shillings (over Sh250 billion currently). However, he probably hasn’t
taken in account the fact that this money is contributed by millions of
people every month – all those in formal employment are required by law
to contribute to NSSF.
The millions of
contributors pay in about sh400 monthly over an average working life of
25 years. Thus, by retirement, the total contribution is just sh120,000.
Supposing that the pensioner lives for another 20 years, then the fund
can only afford to pay just sh500 per month!
Of course, the above
has left out a significant component: the interest earnings of the
contributions. Working with a moderately high return of about 6 percent
per year (pension funds prefer low-risk low-return instruments), it
turns out that the total funds can grow to about Sh260,000 over the
25-year period.
This is now works out
to about Sh1,080 per month – more than double the monthly contribution.
Still, there is another fact to consider: the Sh260,000 is not paid out
in one lumpsum. The payments are made monthly, and the balance left in
the fund continues to earn interest at the same rate of about 6 per
cent.
So, the question to
ask is: if this Sh260,000 is to be paid out over a period of 20 years,
how much should the pensioner get monthly? The calculation is similar to
what banks do in the case of loans on a reducing balance scheme. Only
that, this time, the pensioner is the “lender” and the NSSF is the
“borrower”.
If you borrowed
Sh260,000 at 6 per cent for a period of 20 years, your monthly
installment will be Sh1,860. In short, you contribute Sh400 per month
for 25 years and then, upon retirement, you are paid Sh1,860 every month
for the next 20 years. When viewed this way, it does look very bad; in
fact, it is good! You are being paid more than 4 times what you
contributed.
However, by the time
you retire, your salary will have increased greatly and your lifestyle
follows suit; so, the Sh1,860 will seem like an insult! The lesson here
is this: if you want a big pension; you must contribute more!
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