Ian K Ramdhanie, MSc,
You have decided to leave your job. You are not alone. In a Forbes.com article, contributor Alan Hall said, according to the US Department of Labour's Bureau of Labour Statistics, 2 million Americans leave their jobs – voluntarily – every year.
One is left to wonder what the corresponding statistics are for Trinidad and Tobago; the Sunday BG was unable to access them either at the CSO or the Ministry of Labour. However, the article makes the point that people are quitting for numerous reasons, for better salaries, better work environments and the ability create better work life balance chief among them. Few though, will be quitting for better pensions elsewhere.
As this publication has explored in several past articles, in the US and elsewhere, few companies are making investments in employee benefits like defined benefit pensions. The worker who leaves a job in this environment becomes something of a gambler. Does he hold, fold or walk away when he runs ?
Put another way, the worker has some decisions to make when coming to their pension plan. Do they leave it with their old company ? Do they roll it over to their new company ? Or do cash it out ? Each choice has its implication. To explore them, the Sunday BG spoke Yogendranath Ramsingh, the CEO of Global Financial Brokers Limited, a company that specialises in the provision of employee benefit programmes, as well as other financial and taxation professionals
Knowing your pension plans
If you are an employee who belongs to a company with a defined benefit pension programme, you are in the minority. The Central Bank Financial Stability Report of 2013 said in 2007, 71 per cent of occupational private pension plans were defined benefit. As of 2012, this was reduced to 64 per cent.
The report continues that most of the newly established plans are defined contribution, while most of those being wound up are defined benefit. It said, 'between 2009 and 2012, of the 16 new plans established, 11 were defined contribution. Over the same period, 16 defined benefit programmes and 3 defined contribution plans were wound up.”
Defined benefit pensions are calculated using the employee's final salary as well as length of service, moreover, regardless of the circumstances the company finds itself, it has to pay out pensions—the projections for which may have been made during a different economic climate. Ramsingh gave more insight.
“One of the problems with defined benefit is that it is good from a union standpoint, but it is not good from a company standpoint. With the defined benefit, any liability that is arising, the company is obligated to meet that liability.”
Ramsingh explained that arising out of the Clico issue, stronger regulation for insurance and pensions was coming where companies faced hefty fines, for not filing timely reports on their plan's performance. The administration of these funds and the reporting procedure itself, created additional costs for organisations looking for ways to save money.
Defined contribution gives business a way to cut down, by first of all not having employers make contributions to the fund and then paying out only what is available in the fund after investments, with no guarantee of a particular rate. In defined contribution plans, a certain amount is set aside for the employee, this amount, the contribution is defined, the benefit however, is not.
In the present low interest rate environment, defined contribution plans make things easier for the employer but pose problems for companies with defined benefit plans.
“What has happened is that our investment climate has gone south really, really badly. So the projections for those plans have not materialised. What you have had happen is that people's salaries have increased, their tenure has increased, so therefore the liability has also increased. However, the funding requirement has not matched what it was projected to be. So, the majority of pension funds that we are aware of are in deficit.” said Ramsingh.
“We did a survey on the ones that were registered with Central Bank. There were very few, Republic Bank being one of them, that were actually in surplus. They actually have a few that are in surplus, but the majority of them are not.”
The FSR 2013 said as of March 2013, there were 189 active plans. The report had results for the performance of 85 of these. For the period 2007-2009, 60 were in surplus, 22 were in deficit. The average funded ratio of all those in surplus was 162. Meanwhile, the average funded ratio of the plans in deficit was 86. The average funded ratio figures indicate the extent of the surplus or the deficit. In 2010 to 2012, there were 50 plans in surplus and 35 plans in deficit.
Average funded ratio of all those in surplus was 151, those in deficit 87. This represents a 16 per cent increase in the number of plans that cannot currently meet their obligations with the funds they have. There has also been a decline in surplus amounts over the two different periods.
Ramsingh also revealed a middle road between defined benefit and defined contribution that he said Global Finance Ltd. is advising companies to take, that of hybrid pension plan.
These are plans that have an individual account for the employee and a corporate account for the company. Ramsingh said that Section 134:6 of the Income Tax Act makes allowances for plans under the hybrid model to have companies create these two separate accounts.
When someone leaves a company which has this plan, Ramsingh said while they are free to access the funds in their individual account, they are not allowed to touch the corporate account. Funds from that will only be paid out when the person reaches retirement age.
How your pension plan affects your options
Ramsingh said that the Board of Inland Revenue and current legislation allow portability of defined benefit, defined contribution and hybrid plans to some extent, if, an employee chooses to leave his job and carry his contributions with him.
The Chief Financial Officer of one major company the Sunday BG spoke with said at his company, which has a defined benefit plan, employees need to be working for at least a year to qualify. He said if an employee decided to leave, the standard with most plans was that there was a period after which, one would not be able to withdraw funds. He illustrated using an example from his own career, where after 15 years at his previous firm, he was not allowed to cash in his plan, but has to wait for his retirement.
He said a standard period by which one became ineligible to cash out a pension was usually 5 years. He expressed skepticism about moving the funds, however.
“I don't know if that is practical...You are going to go into a plan that has been performing before you joined the company, the plan might have a surplus, the plan might have a deficit, you don't know, I just think that if you come with your lump sum of $50,000 and drop it into a brand new plan, if it has a deficit, you might be funding that deficit. If it is in surplus, what portion of that surplus will you be entitled to ?”
On this point, Ramsingh said, if the employee had confidence in the performance of his old company, they could leave the money in the plan until their retirement. “If you are at Republic Bank, the plan is in surplus right now and they have done consistently well. One can contemplate leaving what is there, if one goes to another company and one can start your new plan.”
A choice to carry the plan could kick start a long and onerous process though, between the Board of Inland Revenue, the former employer and the new one, particularly with defined benefit and defined contribution plans
“You will have to get approvals from the entities involved to allow the shift to take place. Whether it is Republic Bank or whether it is the new trustee of the entity you are going to. You will have to have approval to say that you are willing to transfer this amount and how much the amount is. Board of Inland Revenue will have to get involved and then they will have to give the approval that they are getting involved. They will have to give the approval that they are authorising this (the transaction). Those things take a while. Eventually, the bank will cut the check and they will transfer it to the new entity.”
Ramsingh said with a defined contribution plan, there may even need to be the actuarial certification of the details of the account before the transfer could be affected. Movement under hybrid plans is much easier according, to Ramsingh. He drew another example with one of Global Finance’s clients Repsol, for whom Global recommended the hybrid option.
“If I am with Repsol and I want to go to Worley Parsons, you can transfer the policy. What happens is that the ownership changes, but what never changes is that this is for the benefit of the employee. So there is mobility to transfer the name, the owner.” He also said if people leave to form their own businesses, under a hybrid plan, they could even assume ownership of their own plan.
Ramsingh emphasised that what happened in actuality spans a range depending on the companies involved, their respective cultures and the rules of their various plans. The Global Finance CEO said there were things to be aware of when considering cashing out your pension. The use of the lump sum was one of them. Ramsingh said most people used their lump sums for current expenses forgetting that they now have no pension to support them when they are older.
“Look at Caroni workers. When they got the lump sums, very few of them, dealt with these lump sums in a responsible manner. Invariably, they have been dissipated and for a variety of reasons. On liming, on cars, and this, because most people wouldn't have gotten a lump sum before in hand.” He said from a recommendation standpoint, Global usually does not advocate giving employees full access to their pensions before retirement. The CFO the Sunday BG spoke to also raised the issue of taxes.
“If you do decide to withdraw it, to take it out, you will be subject to taxes on it because you would have gotten tax benefits at the time of investing. Now that you have taken it out, the Board of Inland Revenue is going to assess it and is going to tax you on it.”
Allyson West, a partner at PWC, specialising in tax matters, said withdrawals from pension plans are taxed at 25 per cent. Recent legislation has standardised this amount. Legislative changes have also made it possible for individuals to have free transfer of their company’s contributions. She said while portability for defined benefit, defined contribution and hybrid plans was theoretically possible, in practical terms, most plans will have to be amended individually to accomodate this.
Ramsingh also said consideration had to be given to other instruments the cashed out lump sum could be invested in, the charges involved and the return on investment and whether this would in fact be better outside of the original pension plan, from which it was taken. He introduced the concept of front end loads that may apply if one decided to invest in an insurance product for retirement.
The front end load are deductions made from your policy to take care of things like the cost of administrating the policy and commission payments to agents. “In terms of what is allocated to grow for you, it might be 30-40 per cent of your initial payment. There are some companies that have chosen to go the way of what they term to be 'no load'.
But there is no free lunch. There are back end charges. When you get to the point of accessing funds, the annuity factor (on no load products) is far lower than the ones with front end load. For examples, putting an annuity factor, let's say of 10 on the front end load, on the ones that are no load, they may give you 5-6. What that translates into is less money for you at the end.”
According to the investment site Investopaedia, the annuity factor is a formula used to determine withdrawals that can be made from a plan, without incurring penalties