CHAPTER ONE

INTRODUCTION TO PENSION SCHEMES

Objectives

1. To define pension funds 2. Explain types of pension plans 3. Classify pension plans

PENSION FUNDS.
This is any plan or scheme that provides retirement income.

Pension is any arrangement to provide people with income when they are not in a regular
employment. Retirement plans are pensions granted upon retirement. Pension funds provide the
cornerstone for financially secure retirement for employer and employees.

In Kenya, every working individual can deduct up to 20,000 shillings per month tax free from
their remuneration .when these funds are placed in pension funds; they earn tax free return until
retirement.

Pension fund manager refers to pension institution licensed by RBA to manage a portfolio of
investments in accordance with the stated goals of funds.

Types of pension plans

1. defined benefit
Refers to an employer sponsored retirement plan where an employee benefits are sort out
using factors as duration of employment and salary investments risk and portfolio
management are entirely under the control of the employer. There are no restrictions on
withdrawal of how and when. Also known as non-qualified benefit plans.

2. hybrid pension plans

Are designed to combine the features of defined contribution plans and defined benefits.e.g a
hybrid plan may provide benefits based on a formula such as defined benefit plan but pension
benefit are expressed as an account balance as defined contribution plan.
3. defined contribution plan:
Defined contribution plan refers to the contribution of investment returns on individual scale.
Certain amount or percentage of money is set aside each year for the benefit of employee.
There are no restrictions as to how or when one can withdraw these funds without penalties.
The amount contributed is fixed but the benefit is not.

4. Cash balance plan

It is a hybrid defined benefit plan that uses a formula to determine benefits but expresses these
benefits as accounts balances. Plans made by the employer with the help of the consulting
actuaries. They have notion balance in hypothetical accounts where typically each of the plan
administrators will contribute an amount equal to a certain percentage of each participant salary.

5. Qualified plan and non-qualified plan

A qualified plan is a plan that satisfies a certain condition set forth by various statues or
regulatory bodies or authority i.e. RBA

6. Non-qualified plans

These are plans that do not meet the needed conditions for tax qualification and other
requirements under statutory requirements and regulatory.

7. ESOP (Employees Share Ownership Plans)

Plan by employer to enable employees acquire shares in the company .it is a defined contribution
plan that requires the plans sponsor to invest plans assets primarily in employers stock.

8. Umbrella refund

An arrangement whereby the company or individual shares a common custodian administration

and fund manager. It happens to small companies and individuals who want to invest
together .the fund manager makes decisions on portfolio investments.
9. Guaranteed fund

These are pension funds with minimum guaranteed annual return. This is common with many
insurance companies offering pension plans. The insurance company makes all decisions
regarding portfolio investments.

10. Segregated fund

This is a fund formed typically by a large company with 25 or more employees. The company
appoints their own dedicated custodian, administrator and fund manager. The fund manager and
the company make decisions regarding portfolio investment.

CLASSIFICATIONS OF PENSION’S FUNDS

OPEN VS.CLOSED PENSION FUNDS
Open pension funds support at least one pension plan with no restriction on membership while
closed pension funds support only pension plans that are limited to certain employees.

Closed pension fund –your company pension may be closed or frozen if it runs out of money.
For instance, if the total value of your company pension scheme’s investments is less than either:

• The amount it has to pay out now.

• The amount it is due to pay out in the future (which includes all the member’s
contributions so far)

The trustees who look after your company pension scheme are responsible for making sure it
does not run out of money. But if your company pension scheme does run out of money then the
employer or the trustees can either:

• ‘Close’ the company pension scheme to new members-existing members can continue to
contribute and receive a pension
• ‘freeze’ the company pension scheme –closed to everyone and existing members benefits
will be affected {depending on the pension plan rules}
PUBLIC vs. PRIVATE PENSION FUNDS
A public pension fund is one that is regulated under public sector law while a private pension
fund is regulated under private sector law. In certain countries the distinction between public or
government pension funds and private pension funds may be difficult to assess.

Tax advantage of sponsoring a qualified plan

• The amount that the employer earns is tax deductive.

• Earnings from investment of the plan assets are tax exempted.

• Participants do not have to pay income tax on employer contribution to the plan on their
behalf or on the earning to that contribution unless they are received.

• Income tax on certain distribution may be deferred by rolling over the distribution into
individual retirement account or to another retirement plan.

• Installment or annually payments are taxed only when the participant receives them.

PENSION PORTABILITY

This refers to the ability of plan participants to transfer accrued benefits from one plan to
another.

PENSION SHORT FALL

Situation in which a company offers employees a defined benefit plan does not have enough
money set aside to meet pension obligation to employees who will retire in the future. It can be
rectified by increasing investment returns or putting more money in the pension plan thereby
reducing the company’s net income.

PLAN FIDUCIARY

This is a person who has disgrenary control or authority over the administrator and management
of the plan including management of the assets.
Review Questions
1. Define pension plans
2. Distinguish between different types of pension plans giving example in Kenya
3. List the tax advantages of sponsoring a qualified plan