Planning for retirement is one of the most important financial decisions you will ever make. When that time comes, it is essential to understand how you can access the money you have been diligently saving over the years in a pension benefits fund.
What are you entitled to upon retirement?
Upon retirement, you become entitled to the full value of your pension benefits. This includes not only the contributions made by you and your employer but also the investment returns (interest), earned over the years. These returns are typically compounded annually, meaning your savings will have grown exponentially over time and so the final amount at retirement will be significantly higher than your actual contributions.
On attaining retirement age and having built a pension pot of let’s say Sh5 million, there are a couple of decisions you will need to make. The most immediate is whether to take a lump sum or opt for regular monthly payments. The option you choose often depends on the type of retirement fund you are enrolled in.
There are two main types of retirement funds in Kenya: provident funds and pension funds. With provident funds, the law allows you to withdraw 100 percent of your accumulated savings as a cash lump sum. This provides you with flexibility to use part or all of the funds to purchase a post-retirement monthly income product like an annuity or income drawdown. On the other hand, with a pension fund, the law allows you to only access one-third of your benefits as a lump sum. The remaining two-thirds must be used to secure a post-retirement regular income, either through an annuity or an income drawdown plan. Depending on the size of your accumulated retirement fund you can select a mix of the two post-retirement solutions
What is annuity and income drawdown?
Understanding the difference between annuity and income drawdown (IDD) is critical before making your decision. An annuity is a contract with an insurance company whereby you hand over your retirement savings as a one-time premium payment to the insurance company and in return, the insurer pays you a predetermined income (monthly, quarterly or annual) for the rest of your life. The advantage here is predictability as you will receive an income that is not affected by market performance. In the event of your passing away, the payments typically stop unless you included options like a joint annuity or a guaranteed period that surpasses your life.
An income drawdown on the other hand allows you to keep your retirement savings in an investment. Your money is held by a fund manager licensed by the Retirement Benefits Authority (RBA) and you receive regular payments drawn directly from your fund balance. These payments can be paid monthly, quarterly, or annually, depending on your preference. The remaining balance continues to earn investment returns, which are credited annually after audit. The main benefit of Income Draw Down is the flexibility it offers on withdrawals, the security of the funds upon demise of the principal member and the potential of your funds to grow. However, on the flip side is that poor investment performance could reduce the value of your fund, hence affecting future payouts. In Kenya, RBA caps annual withdrawals at 12 percent of your opening balance to protect your funds from being depleted too quickly.
So which option is better? That depends on your circumstances. Many retirees are tempted to take their entire pension as a lump sum and start a business. Unfortunately, a research done by RBA in 2018 indicates that within two to three years, 60 percent of those businesses fail and the savings are gone. To avoid that risk, financial experts often recommend choosing an annuity or income drawdown plan to ensure a steady income throughout retirement. These options provide financial security and help replace your salary with regular payments, enabling you to manage your expenses comfortably.
To give you an idea of how these monthly payments are calculated, let’s use a simple example. Suppose you retire with Sh5 million. In the case of an annuity, most insurers use a rough estimate of one percent of your lumpsum to determine monthly payouts. That means you could expect about Sh50,000 per month for life. Different insurance companies may offer slightly different rates based on your age, gender, and additional features like guaranteed period or joint annuities.
For those leaning towards an income drawdown, it is important to understand how the 12 percent annual limit works. For instance, if you start with Sh5 million, you can withdraw up to Sh600,000 in a year. That works out to around Sh50,000 per month if you choose monthly payments. This cap helps ensure your money lasts your retirement life but the actual value of your income will fluctuate each year depending on your fund’s balance and investment performance. If returns are strong for instance at 15 percent, your fund will grow despite the withdrawals. But if returns fall below 12 percent, your savings will shrink faster.
Timing also plays a role. If you choose an immediate annuity, payments begin as soon as the insurance company receives your pension funds and completes the onboarding process. This could be within the same month of your retirement. Alternatively, you might opt for a deferred annuity, where you purchase the product now but schedule payments to begin at a determined period in the future. This gives your funds more time to grow, potentially increasing your future payouts. There are also joint annuities, which allow payments to continue to your spouse after your death, and annuities with arrears, which make up for delayed payment processing by paying out retrospectively.
Ultimately, there is no one-size-fits-all answer. Your decision should reflect your personal needs, spending habits, health outlook, and financial literacy. Understand the type of retirement fund you are enrolled in, explore the post-retirement income options available, and seek guidance from licensed financial advisors. After all, your retirement years should be enjoyed in comfort and dignity and that begins with making informed decisions today.
The writer is a Financial Communication Strategist and Senior Brand, Marketing and Communications Advisor at Zamara Group Limited
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