Retirement funds industry needs more reforms

President Jakaya Kikwete visits modern maternity ward at Temeke Municipality hospital during his official tour of Temeke District in Dar es Salaam yesterday. (Photo: Tryphone Mweji)

 

By CAROL WAHINYA

There is a common belief that if one was to draw an age-earning capacity graph then it would disclose a bell’s curve with the earning capacity starting at zero when a person is born, rising to the maximum at about the ages of 35 to 45 and progressively dropping back to zero.

Naturally, there are many assumptions about this and it is not always the case that a bell’s curve shall be followed, though in a majority of cases, the assumptions shall stand.

Whatever the situation, it is always prudent to ensure that a portion of the earnings is kept aside to cater for the period when the earning capacity is reduced.

At the end of the day, there are a number of savings schemes that people may wish to employ and which range from mutual funds and insurance funds to pension schemes to personal savings accounts, all of which ideally are intended to serve more or less the same purpose – set money aside for some contingent event.

THE PECULIARITY of "retirement benefits funds" is that the driving force is to supplement income when the bell’s curve moves back towards zero as a result of advancement in age. For this reason, it becomes advisable to supplement the formal savings through retirement funds with diversification of income through investment in passive income portfolios such as blue chip company stocks, Treasury bills and bonds, and insurance covers.

Though the diversification of savings is a brilliant idea theoretically, its practicability is different, especially in this part of the world.

Investment in shares and bonds would be tricky as the stock exchange markets are not very well developed. Besides, majority of the population does not know how stocks and money markets operate.

MORE FUNDAMENTAL, however, is the fact the majority of people are not in formal employment and their incomes are only enough for their basic needs. Even those who are employed are often below the poverty line and live from hand to mouth.For such poor people, every cent counts and they would prefer to have the money today and let tomorrow take care of itself.

The government has for long demanded that mandatory savings in the form of retirement schemes be undertaken. Unfortunately, due to the inherent complexity of trying to enforce this on persons in business or informal employment, this would apply only to those in formal employment,

At a very fundamental level, the law requires every "employee" to put a certain percentage of her income into a retirement fund every month. The employer is expected to match what the employee has contributed. These are known as "contributory retirement benefit schemes".

The fact that the employer is forced to contribute an amount equal to what the employee contributes has effects beyond the obvious financial implications, chief among them being that the employer is seen to be contributing to the future welfare of the employee and not just paying for services rendered.

TALKING OF percentages to be contributed, the largest retirement benefits scheme, the NSSF, requires a 10 per cent contribution of gross income by both employer and employee, making the total contribution equivalent to 20 per cent of the employee’s gross income. Gross income includes the basic pay and all allowances and benefits that the employee derives from the employer.

There have been a number of fundamental changes in the retirement benefit schemes in the past year, the most glaring being in the way the contributions attract tax. The previous law (Income Tax Act 1973) provided that the employees’ contribution to the pension fund was out of already taxed income.

This meant that one would have to pay the taxes and only then make his pension contributions. The pension contributions could thus be seen to have the same tax effect as dividends that are paid from after-tax profits. In effect, the contributions would have already suffered taxation before they are remitted to the fund.

In the new Income Tax Act (Income Tax Act 2004), the contribution is a tax deductible expense for the employee, that is, one would first deduct the 10 per cent pension from the gross pay and then tax the balance. Nothing much changes from the employer’s end and the contributions remain tax deductible expense in the company’s profit and loss account. Another change is in the payments from the scheme.

Whereas previously there were no taxes to be paid when one obtained his retirement funds (mainly due to the fact that the contributions had been taxed anyway and taxing the payments would typically be double taxation), the current Income Tax Act provides for a withholding tax of 10 per cent against payments to resident persons and 15 per cent against non-residents.

The new tax Act is favourable to the pensioner. For example, whereas under the old tax Act an employee's contributions of Tsh100,000 would be taxed at 30 per cent – giving rise to a tax of Tsh30,000 – the amount is not taxed on receipt.

UNDER THE new Act the same Tsh100,000 is contributed tax free, and taxed at 10 per cent on receipt, giving rise to a tax of Tsh10,000.

True to the name that they are "retirement benefits", one does not get access to the funds simply by reason of leaving the employment of the current employer.

The employee is expected to wait until the age of 55-60 to withdraw the benefits, which is a long time to have to wait, especially when one considers that life expectancy has significantly dropped, not to mention the fact that fewer and fewer people are waiting for the golden age of 55 to retire.

One proposal is to make the withdrawal of benefits optional when one attains, for example, 40 years then at age 50 and finally at age 55-60, depending on one’s personal circumstances. The danger here is that more people would prefer to withdraw early.

There are, however, certain exceptions to the rules allowing one to withdraw from the scheme before retirement age. These include cases where one leaves the country permanently or the premature demise of the contributor (though this can hardly be considered an option).

Notwithstanding the obvious benefits that retirement benefits schemes provide, there is a general lack of diversity in the choice of retirement benefit funds.

There are currently less than 10 funds that have been established by various Acts of parliament to choose from, among them the Local Government Pension Fund, the Parastatals Pension Fund, the National Social Security Fund, the National Pensions Fund and the Political Leaders' Pension Fund.

The fact that all the funds have a government connection creates some level of economic and financial risk, especially in the event that the funds find themselves in hard times.

There are also some who argue that bodies with government connection cannot possibly be as good at financial investments as private-sector investors, though they will all readily admit that it is always safer to invest with the government than privately.

Proposals to liberalise the retirement benefits industry by allowing employers to set up their own pension funds schemes, which naturally would have to be regulated by some quasi-government organisation, are seen as the right steps towards creating a vibrant retirement funds industry.

Whether this holds water or not is a matter of conjecture, what is a fact is that such liberalisation shall increase the choices that both employers and employees have.

Carol Wahinya is a tax manager at Deloitte & Touche, Tanzania.