Understanding Pension Plans
May 27, 2013
The term pension scheme or pension plan is applied generally to atax-exempt arrangement that provides pension payments and other benefits usually on the retirement or death of a member in return for contributions by, or in respect of that member.
The contributions made go towards a pool of funds set aside for the members’ future benefit. The pool of funds is then invested on the members’ behalf, allowing members to receive benefits upon retirement. [EXPAND Read more]
In Jamaica, pension plans and retirement schemes are usually tax exempt once they are approved under the Income Tax and Pensions acts.
The main benefit provided by a pension plan or retirement scheme is a pension income to the member and his or her dependents. Other benefits include a lump-sum payment on death or retirement.
Usually, the pension plan arrangement is established in connection with the members’ employers and hence referred to as occupational pension schemes. The individual retirement schemes are established mainly by financial institutions such as NCB Insurance Company Limited for persons who are not a part of an occupational plan, usually self-employed individuals, small to medium-size corporations and for those who are not in a pensionable post.
There are different terms used to refer to pension plans, these are pension scheme, retirement scheme, individual retirement account and superannuation fund. However, there is a distinction in the Pensions Act between:
Approved Superannuation Fund (ASF)
Approved Superannuation Scheme (ARS)
When an ASF is mentioned, reference is being made to an occupational pension plan while ARS is referring to an individual retirement account.
There are two main types of pension plan arrangements: Defined Contribution (DC) Plan and Defined Benefit (DB) Plan. They can either be contributory where the member and employer contribute towards the benefit or non-contributory where only the employer contributes.
In a Defined Contribution plan, the contribution made on behalf of each member is used to provide a pension benefit. The benefit received at retirement by the member is limited to his/her contributions and the employer’s contributions, plus transfers from ARS/ASF, if any, all accumulated with interest earned. Therefore, the benefit received by the employee is highly dependent on the contributions made over time and the performance of the pension plan’s assets.
In a Defined Benefit plan, the employer guarantees that the member will receive a definite amount of pension benefit upon retirement, regardless of the performance of the pool of assets or whether or not there is a surplus of assets over liability in the pension plan. Surplus in a pension plan is derived from investment performance and/or forfeiture of the employer’s contributions by members due to termination before retirement. This surplus, or a part thereof, can be distributed among the participants of the plan, subject to the rules, and is usually based on the recommendation of the plan’s actuary and to the approval of the trustees and/or the employer.
If there is a surplus, then this may be distributed in the following ways:
1. Bonus to be credited to members’ account: The trustees could distribute bonus to active members’ account and or the deferred pensioners’ account. This bonus cannot be withdrawn from the plan while in active employment of the sponsor and is an enhancement to the members’ account which will improve his/her retirement income.
2. Trustees could approve benefit improvements given to the pensioners in the form of an increase in pension payment, in line with the consumer price index or a fixed rate of increase.
Some additional benefit improvements under a DB plan could be to improve spouses’ pension, improve the accrued rate which is limited to a maximum of two per cent under the Income Tax Act and also the plan could provide a death benefit for pensioners. [/EXPAND]