Revisiting the purpose of a pension fund
Marthinuz Ndumetana Fabianus
The recent war of words between the Governments Institutions Pension Fund (GIPF) and firebrand activist Dr Job Amupanda calls for re-examining a pension fund's purpose.
For starters, I believe the public spat could have been avoided through direct engagement and by establishing areas for improved education to members on the design and legal framework of GIPF and pension funds in general.
But the fundamental issues raised in this discourse focus the spotlight on the main purpose of a pension fund and whether that purpose best serves our country’s modern-day social needs. Various other questions have been raised that lay bare some commonly held misconceptions about the workings of pension funds. We have an excellent opportunity to consider what the purpose of a pension fund should be, given our socio-economic realities.
To my mind, there are substantive questions we cannot ignore. I accept that some of the questions cannot be fully dealt with on a single page while ensuring that the average person can understand the answers. Here is my attempt to answer some questions I consider key to this public debate.
Defined benefit fund
The reasons why GIPF may find specific questions hard to answer lie within the fundamental differences between the above two distinctive pension fund models. A defined benefit pension fund implies that the benefit at retirement is defined per a set formula. This formula determines the benefit payable to a member upon retirement age.
The formula multiplies a certain percentage (between 1.5% up to say 2%) of the average pension contribution salary by the number of years of membership (i.e. say 2% x average pension contribution salary x years of membership = benefit).
With this model, a member does not even know how much of the ‘supposed’ contribution made on their behalf by the employer the fund allocates to them. By its very nature, a defined benefit fund does not focus on maintaining up-to-date and accurate individual accounts per member. Instead, the amount paid by the employer is allocated to members based on how close they are to retirement age. So, older members will have more money put towards their benefits than younger members. Since the focus is placed more on the benefit payable at retirement, which is determined by the formula explained above, members who leave before retirement may feel short-changed.
Defined contribution fund
By contrast, a defined contribution fund states the “specific contribution by members and the employer to the fund as a percentage of salary”. It then allocates these individually for each member of the fund. In any given month, the benefit in each member’s account in the fund is equal to member contribution plus employer contribution plus interest earned.
GIPF is the only remaining defined benefit fund in the country. All other State-owned enterprise and private-sector employer pension funds operate as defined contribution funds. Accurate record-keeping in a defined contribution pension fund is paramount because no cross-subsidisation may take place. Because under defined benefit funds, the employer contribution is allocated to members depending on their proximity to retirement age, younger members cross-subsidise older members. It is worth repeating this point, as it becomes relevant when one looks at the question regarding housing loans further on.
Pension fund vs provident fund
The Income Tax Act determines the difference between a pension fund and a provident fund. The Act allows provident fund members to be paid their total benefit at retirement in cash. In contrast, pension fund members can only be paid out a maximum of one third of the total accumulated benefit in cash. The remaining two thirds must be used to provide the member with recurring pension payments for life.
The recurring pension payments can be determined in various ways, and with various terms and conditions I will not deal with here. Whether to set up a fund as pension or provident is a decision entirely up to the fund board, but takes into account the sponsor's (i.e. the employer) and members’ (usually represented on the board) preferences. Of course, market trends and a competitive labour environment are amongst the factors that inform this decision.
Housing loans issue
Should a pension fund use member fund credits to guarantee housing loans by third-party financial institutions or grant the loans directly to members from the fund?
Since its inception, the Pension Funds Act of 1956 [Section 19 (5) (a)] has stated that pension funds may let members use part of their pension fund benefits (currently up to 90% of the benefit that would be paid upon resignation) for housing. Any housing loan must be granted before and repaid by the member’s retirement date. Housing was already considered a national priority back in 1956 when the law was first crafted. Under the law at present, members of a fund can either use their fund credit as a guarantee for a loan from a financial institution or borrow directly from the fund credit for purposes of housing. However, which of the two avenues to use is up to the trustees of a pension fund to decide and to provide for in the rules of the fund.
No fund can give direct housing loans or let members use their fund credits to guarantee housing loans unless the fund rules allow this. Whether trustees must allow members to use the funds to their credit as guarantees for loans by a financial institution or grant that loan directly to the member is really at the crux of this matter in the case of the GIPF. In the case of a defined contribution fund referred to earlier, it is easy to administer individual loan accounts, as the pension fund credits of members are already maintained in the same manner. Not so simple for defined benefit funds, though. Why a defined benefit fund cannot easily give direct housing loans to its members cannot be easily explored here. However, it may be worth pointing out that to my knowledge, no defined benefit fund offers direct housing loans to members, not even in South Africa that shares the same Pension Funds Act of 1956.
Access to pension fund savings
Should members be allowed to access their pension fund savings for other purposes before reaching retirement?
This question requires broader discourse and robust public education. To the credit of Dr Amupanda, I did not hear him suggesting that members be allowed to access their pension fund savings for anything other than housing purposes. He probably realises that pension funds serve a noble purpose of protecting assets to provide their members with a dignified life after retirement. We have been proponents for funding one’s children's education from pension fund credits (just like with housing loans) due to the high costs and positive socio-economic benefits of education. As the ‘great leveller’, education is a national priority. To go beyond these two purposes would, in my view, be disastrous for the economic well-being of our nation.
Pension fund assets are the bedrock of our country’s economy. Without this foundation, our economy would possibly have collapsed, and our entire financial system would not be on par with those of well-developed economies.
What other benefits do pension funds pay besides benefits at retirement?
Almost all occupational pension funds in Namibia provide other auxiliary benefits on a member’s death and permanent incapacity (disablement). Benefits on the member’s death aim to provide for legal dependants (spouses and minor children). Where the member is the sole or primary breadwinner, these benefits even assist extended family (parents, siblings, relatives, etc) who would otherwise be destitute.
Investing pension fund monies
How/where should pension fund monies be invested?
This question also requires more in-depth explanations and robust public discourse and education. The current Pension Funds Act (soon to be replaced by the Financial Institutions and Markets Bill) provides for pension fund monies to be invested geographically as 45% (minimum) in Namibia, 1.75% (minimum) in unlisted investments in Namibia, 35% (maximum) in overseas markets and, by implication, the remainder of 18.25% in South Africa.
As the saying goes, “there's no worse fool than an old fool”.
Since Namibia’s independence, most employers have realised the benefit of employee retirement provision and, spurred on by social and moral obligations, have sponsored pension funds for their employees. Whether by default, design or coincidence, the occupational pension sector has grown in leaps and bounds over the last 30 years.
It is today the most significant catalyst and enabler for economic development in Namibia. The average total contribution to occupational pension funds is around 17% of employee earnings, shared between employee and employer, with employees typically contributing 7.5% of earnings. Most pension funds allow their members to use their savings for housing purposes. The majority use the loan guarantee route (through financial institutions) - the direct loan route is less common.
In the case of defined contribution funds, it should not matter which route the member chooses, accepting that there are pros and cons for either.
I conclude by repeating that our laws (even the colonial era Pension Fund Act of 1956) are flexible enough as they currently are to satisfactorily address most - if not all - substantive questions referred to above.
Ultimately, the trustees of a pension fund board, as represented by both members and sponsor, should decide what type of fund and benefits to offer, taking their unique circumstances into account.
*Marthinuz Ndumetana Fabianus is the managing director of Retirement Fund Solutions, Namibia’s biggest administrator of occupational pension funds outside of the Government Institutions Pension Fund. He has over 25 years of experience. He wrote this in his private capacity.
The recent war of words between the Governments Institutions Pension Fund (GIPF) and firebrand activist Dr Job Amupanda calls for re-examining a pension fund's purpose.
For starters, I believe the public spat could have been avoided through direct engagement and by establishing areas for improved education to members on the design and legal framework of GIPF and pension funds in general.
But the fundamental issues raised in this discourse focus the spotlight on the main purpose of a pension fund and whether that purpose best serves our country’s modern-day social needs. Various other questions have been raised that lay bare some commonly held misconceptions about the workings of pension funds. We have an excellent opportunity to consider what the purpose of a pension fund should be, given our socio-economic realities.
To my mind, there are substantive questions we cannot ignore. I accept that some of the questions cannot be fully dealt with on a single page while ensuring that the average person can understand the answers. Here is my attempt to answer some questions I consider key to this public debate.
Defined benefit fund
The reasons why GIPF may find specific questions hard to answer lie within the fundamental differences between the above two distinctive pension fund models. A defined benefit pension fund implies that the benefit at retirement is defined per a set formula. This formula determines the benefit payable to a member upon retirement age.
The formula multiplies a certain percentage (between 1.5% up to say 2%) of the average pension contribution salary by the number of years of membership (i.e. say 2% x average pension contribution salary x years of membership = benefit).
With this model, a member does not even know how much of the ‘supposed’ contribution made on their behalf by the employer the fund allocates to them. By its very nature, a defined benefit fund does not focus on maintaining up-to-date and accurate individual accounts per member. Instead, the amount paid by the employer is allocated to members based on how close they are to retirement age. So, older members will have more money put towards their benefits than younger members. Since the focus is placed more on the benefit payable at retirement, which is determined by the formula explained above, members who leave before retirement may feel short-changed.
Defined contribution fund
By contrast, a defined contribution fund states the “specific contribution by members and the employer to the fund as a percentage of salary”. It then allocates these individually for each member of the fund. In any given month, the benefit in each member’s account in the fund is equal to member contribution plus employer contribution plus interest earned.
GIPF is the only remaining defined benefit fund in the country. All other State-owned enterprise and private-sector employer pension funds operate as defined contribution funds. Accurate record-keeping in a defined contribution pension fund is paramount because no cross-subsidisation may take place. Because under defined benefit funds, the employer contribution is allocated to members depending on their proximity to retirement age, younger members cross-subsidise older members. It is worth repeating this point, as it becomes relevant when one looks at the question regarding housing loans further on.
Pension fund vs provident fund
The Income Tax Act determines the difference between a pension fund and a provident fund. The Act allows provident fund members to be paid their total benefit at retirement in cash. In contrast, pension fund members can only be paid out a maximum of one third of the total accumulated benefit in cash. The remaining two thirds must be used to provide the member with recurring pension payments for life.
The recurring pension payments can be determined in various ways, and with various terms and conditions I will not deal with here. Whether to set up a fund as pension or provident is a decision entirely up to the fund board, but takes into account the sponsor's (i.e. the employer) and members’ (usually represented on the board) preferences. Of course, market trends and a competitive labour environment are amongst the factors that inform this decision.
Housing loans issue
Should a pension fund use member fund credits to guarantee housing loans by third-party financial institutions or grant the loans directly to members from the fund?
Since its inception, the Pension Funds Act of 1956 [Section 19 (5) (a)] has stated that pension funds may let members use part of their pension fund benefits (currently up to 90% of the benefit that would be paid upon resignation) for housing. Any housing loan must be granted before and repaid by the member’s retirement date. Housing was already considered a national priority back in 1956 when the law was first crafted. Under the law at present, members of a fund can either use their fund credit as a guarantee for a loan from a financial institution or borrow directly from the fund credit for purposes of housing. However, which of the two avenues to use is up to the trustees of a pension fund to decide and to provide for in the rules of the fund.
No fund can give direct housing loans or let members use their fund credits to guarantee housing loans unless the fund rules allow this. Whether trustees must allow members to use the funds to their credit as guarantees for loans by a financial institution or grant that loan directly to the member is really at the crux of this matter in the case of the GIPF. In the case of a defined contribution fund referred to earlier, it is easy to administer individual loan accounts, as the pension fund credits of members are already maintained in the same manner. Not so simple for defined benefit funds, though. Why a defined benefit fund cannot easily give direct housing loans to its members cannot be easily explored here. However, it may be worth pointing out that to my knowledge, no defined benefit fund offers direct housing loans to members, not even in South Africa that shares the same Pension Funds Act of 1956.
Access to pension fund savings
Should members be allowed to access their pension fund savings for other purposes before reaching retirement?
This question requires broader discourse and robust public education. To the credit of Dr Amupanda, I did not hear him suggesting that members be allowed to access their pension fund savings for anything other than housing purposes. He probably realises that pension funds serve a noble purpose of protecting assets to provide their members with a dignified life after retirement. We have been proponents for funding one’s children's education from pension fund credits (just like with housing loans) due to the high costs and positive socio-economic benefits of education. As the ‘great leveller’, education is a national priority. To go beyond these two purposes would, in my view, be disastrous for the economic well-being of our nation.
Pension fund assets are the bedrock of our country’s economy. Without this foundation, our economy would possibly have collapsed, and our entire financial system would not be on par with those of well-developed economies.
What other benefits do pension funds pay besides benefits at retirement?
Almost all occupational pension funds in Namibia provide other auxiliary benefits on a member’s death and permanent incapacity (disablement). Benefits on the member’s death aim to provide for legal dependants (spouses and minor children). Where the member is the sole or primary breadwinner, these benefits even assist extended family (parents, siblings, relatives, etc) who would otherwise be destitute.
Investing pension fund monies
How/where should pension fund monies be invested?
This question also requires more in-depth explanations and robust public discourse and education. The current Pension Funds Act (soon to be replaced by the Financial Institutions and Markets Bill) provides for pension fund monies to be invested geographically as 45% (minimum) in Namibia, 1.75% (minimum) in unlisted investments in Namibia, 35% (maximum) in overseas markets and, by implication, the remainder of 18.25% in South Africa.
As the saying goes, “there's no worse fool than an old fool”.
Since Namibia’s independence, most employers have realised the benefit of employee retirement provision and, spurred on by social and moral obligations, have sponsored pension funds for their employees. Whether by default, design or coincidence, the occupational pension sector has grown in leaps and bounds over the last 30 years.
It is today the most significant catalyst and enabler for economic development in Namibia. The average total contribution to occupational pension funds is around 17% of employee earnings, shared between employee and employer, with employees typically contributing 7.5% of earnings. Most pension funds allow their members to use their savings for housing purposes. The majority use the loan guarantee route (through financial institutions) - the direct loan route is less common.
In the case of defined contribution funds, it should not matter which route the member chooses, accepting that there are pros and cons for either.
I conclude by repeating that our laws (even the colonial era Pension Fund Act of 1956) are flexible enough as they currently are to satisfactorily address most - if not all - substantive questions referred to above.
Ultimately, the trustees of a pension fund board, as represented by both members and sponsor, should decide what type of fund and benefits to offer, taking their unique circumstances into account.
*Marthinuz Ndumetana Fabianus is the managing director of Retirement Fund Solutions, Namibia’s biggest administrator of occupational pension funds outside of the Government Institutions Pension Fund. He has over 25 years of experience. He wrote this in his private capacity.
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