How Does The Pension Scheme Work?

Anyone who thinks about the future and is more inclined to plan for the days ahead will find sense in putting some money away for the time when they are old. They would certainly need a place to save this money and also a standard plan that holds out for a long period of time while offering a range of benefits. This is exactly why pension schemes exist!

Pension schemes are a tax-efficient way to save money for when employees retire from working. Pension schemes are efficient and flexible and we will get to this bit in a minute. First, let us walk you through the concept of pension.

What is a pension?

The retirement fund that an employer pays or contributes on behalf of an employee is termed pension. This fund can either be contributed by an employer, employee, or both parties where the employer usually contributes the larger percentage.

The pension fund is saved up and accrued over the years of active employment up until the beneficiary retires, after which they are paid an annuity which is a periodic payment of a sum of money to an individual (pensioner) over time.

A more comprehensive definition sees pension as an annuity paid to retirees or retired employees as compensation for the years dedicated to working for an organization or generally for past employment.

There is a lot to say about pensions and how it works but here are three basic details to note as regarding pension;

• Depending on the pension an employee or a worker operates under, they, including other people, can contribute to their pension. The funds are invested on behalf of the employee, and the profit on the investments generates compensation to the worker upon retirement. However, it is important to understand that pensions are usually invested in financial instruments, so there can be fluctuations in the value of the pension and one may get back less than the initial contribution.
• The government adds to an employee’s pension through tax relief. The government assists an employee’s personal or workplace pension in the form of a tax refund or tax relief which is highly dependent on their income bracket. In the case of a basic rate taxpayer, the government adds a certain percentage or amount to their pension contributions. The same applies to a person who pays high or additional tax, the worker can claim additional tax relief.
• Lastly, the employee is entitled to a “money jar” to live on and from for the rest of his/her life if they have a pension. Pensions are paid periodically even up till the death of the retiree and there are options as to how the pension funds can be withdrawn.

What is a pension scheme?

A Pension Scheme, otherwise known as a pension plan, is a profitable way to save money through monetary contributions made by employers, employees, or both parties. The funds are stored in a retirement savings account and accessed upon retirement. In Nigeria, the traditional pension scheme (Contributory Pension Scheme) sees the employer contributing the larger percentage of about 10% of the salary while the employee contributes 8%.

How do pension schemes work?

It doesn’t matter whether the employee works in the private or public sector, or if the individual is self-employed, there are different types of pension schemes that cater to different sectors.

• Contributory Pension Scheme

This scheme can operate in both the private and public sectors and is the common pension scheme in Nigeria. An employee under the contributory pension scheme qualifies for a Retirement Savings Account (RSA) which allows monthly contributions from both the employer and employee. About 15–20% of the employee’s salary is saved in the RSA. The funds are deposited systematically and are usually invested in stocks and shares to yield profits and to protect the pension funds from inflation.

The contributory pension scheme is formulated in such a way that the employer has no control over the employee’s pension investment. The National Pension Commission (PENCOM) regulates the pension fund and contributions under this scheme are usually made monthly.

• Voluntary Contribution Scheme

This scheme is optional and usually utilized in conjunction with the contributory pension scheme. It is a supplementary contribution scheme that allows the employee to make additional contributions to their pension fund. This scheme is flexible and contributions can be made without a fixed schedule (can be weekly, bi-weekly, monthly, bi-monthly, yearly) unlike the RSA that operates monthly.

• Retirement Plan

This plan branches out of the contributory pension scheme and is meant for retired persons. With the retirement plan, pension funds are usually invested in low-risk fixed income instruments such as savings bonds, corporate or government bonds, preferred stocks, or other low-risk financial instruments. However, this pension scheme can only be accessed upon retirement or when the employee is over 55 years of age.

• The Micro Pension Scheme

Self-employed workers also need a plan that works in their favor and this need gave rise to the Micro Pension Scheme. The micro pension scheme was introduced in 2014 and this pension plan is suitable for traders, entrepreneurs, professionals, and other individual business owners that are not eligible for the contributory pension scheme. It is flexible and convenient and the best choice for self-employed individuals.

• Cross-Border Pension Scheme

For employees or workers living outside the country, there is a pension scheme that caters to this set of people. It is possible to save funds from outside the country with this pension scheme. The cross-border pension scheme allows an individual working outside of the country to contribute to the pension funds in their country. The employee’s RSA account will also be denominated in the country’s currency.

Benefits of a pension scheme

There are so many ways to save or invest money. However, pension stands out from the crowd and the right pension plan/ scheme has its benefits and advantages.

• Employees under the pension scheme get tax relief or refunds on pension contributions. The government adds a certain percentage (usually 25% for basic taxpayers) to contributions made to the pension account. There is also a possibility that an employee claims a higher percentage if they fall under the category of additional or higher taxpayers.
• Another benefit associated with pension schemes is that if a worker is employed by an organization, the employer is legally bound to contribute to the employee’s pension funds. Usually, the employer contributes a higher percentage than the employee in a workplace pension.
• Lastly, pension investments are exempt from taxes like income tax and capital gains tax. Employees are not under any obligation to pay tax on earnings from shares or capital gains tax on any gains made from the investments within their pension plan. However, there are guidelines and tax implications regulating withdrawals from different pension schemes.

In precise, the retirement phase is a special period in every worker’s life and it is crucial to plan towards this phase by making well-informed decisions about pension plans to ensure that the employee reaps his/ her full benefits during their retirement years.

Also, the choice of Pension Fund Administrator (PFA) is vital to making sure that the financial needs of employees are met during retirement and this points to the significance of choosing the right PFA.

With PrimePayroll, Pension Fund Administrator (PFA) can be configured such that employee records are related to these records. PrimePayroll then automatically computes monthly emoluments based on percentage contributions by both the employer and employee.