Retirement planning is an essential part of personal finance that can significantly impact an individual’s quality of life during their later years. In the past, simply reaching retirement age was considered a great accomplishment.
However, with advancements in medicine and technology, people live much longer. The goal has shifted to supporting individuals and their partners for 20-30 years in retirement and leaving a financial legacy for their descendants.
The 2021 Retirement Benefits Schemes Investments Performance Survey conducted by ACTSERV revealed that segregated retirement benefits schemes experienced an 11.6% increase in returns in 2021. This was a significant rise from the 7.0% return recorded in 2020.
By engaging in appropriate planning and preparation, one can attain a comfortable retirement and experience financial stability and peace of mind during their golden years.
From this article, you will learn the importance and tips for retirement planning.
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Retirement Schemes in Kenya
Retirement benefit schemes in Kenya are designed to provide financial security to employees in their retirement years. These schemes can be divided into two main types.
1. Defined Benefit Schemes
A defined benefit pension scheme is a retirement plan where the employer promises to pay a specific benefit to employees based on a formula that considers the employee’s salary and length of service.
The employer is responsible for funding the scheme and contributing money to a pension fund to ensure enough money to pay the retirement benefits promised to employees. The primary advantage of a defined benefit scheme is that it provides employees with a guaranteed retirement benefit that is not subject to market fluctuations or other factors.
However, these schemes can be costly for employers to fund, and there is a risk that they may not have enough funds to meet their pension obligations in the future. Changes in the demographic makeup of the workforce or economic conditions may require the employer to adjust the plan’s funding to ensure its solvency.
2. Defined Contribution Schemes
Defined contribution schemes are retirement plans in which the employer and the employee regularly contribute to a fund invested in various assets. The amount of money contributed is not subject to income tax at the time of contribution.
The retirement benefit that the employee receives is based on the amount of money contributed to the fund and the investment returns earned on those contributions. The fund is typically managed by a professional investment manager who invests the contributions in various assets to achieve the highest possible returns for the employees.
The investment risk is transferred from the employer to the employee in defined contribution schemes.
On the contrary, for the defined benefit scheme, the employer is responsible for ensuring that the employee receives a specific retirement benefit, regardless of the performance of the investments.
With a defined contribution scheme, the employer is only responsible for making contributions to the fund, and the employee takes on the investment risk.
Benefits of Retirement Benefit Schemes
Some of the benefits of enrolling in a retirement scheme include:
i) Financial Security
Retirement benefits provide retirees with a regular income stream to cover their expenses, pay bills, and meet their financial obligations.
These benefits help alleviate the stress and anxiety that often comes with not having enough money to live comfortably after retirement.
ii) Long-Term Planning
These benefits allow retirees to plan for their long-term needs and expenses.
They can then use the funds to cover their healthcare costs, travel, and other expenses that may arise in their retirement years.
iii) Employer Contribution
In Kenya, many employers offer retirement benefits as part of their employee compensation package.
This means that the employer contributes to the retirement fund, which helps employees build up their retirement savings over time.
iv) Inflation Protection
Retirement benefits often have cost-of-living adjustments (COLA) to ensure that retirees’ income keeps up with inflation.
This means that the retirement income increases over time to match the rising cost of goods and services, protecting retirees’ purchasing power.
Tips for Retirement Planning
- Start planning early
The earlier you plan and join a retirement plan, the better off you will be.
Doing so gives you more time to save and invest for retirement and allows compound interest to work in your favor.
- Determine your retirement needs
To determine retirement needs, start by evaluating your current expenses and projecting them into the future while accounting for inflation.
Additionally, factor in potential healthcare costs and any anticipated lifestyle changes, such as travel or downsizing.
- Consider different investment options
To achieve financial goals and manage risk, consider various investment options like fixed deposits for a low-risk and low return, mutual funds for moderate risk and return, and pension plans for long-term investment and retirement planning.
- Create a budget
Creating a budget and sticking to it can help you keep track of your expenses, which is crucial for saving enough money for retirement. When you create a budget, you can monitor your spending and ensure you’re allocating sufficient funds towards retirement savings.
- Take advantage of tax benefits
The government of Kenya offers tax benefits for contributions made to a pension scheme.
For a defined contribution scheme, the contributions made by the individual to the pension scheme are eligible for tax relief up to a maximum of 20% of the employee’s annual income or KES400,000 (whichever is lower).
This means that the individual can deduct the amount contributed from their taxable income, reducing the income tax they are liable to pay.
For a defined benefit scheme, the tax relief is based on the actuarial value of the benefit accrued in the year. The benefit accrued is determined by the pension scheme’s rules and is calculated based on the individual’s salary and years of service.
Furthermore, all investment income earned on the contributions made to the pension scheme is tax-free. This means that any returns or interest earned on the contributions will not be subject to income tax, providing an opportunity for long-term retirement savings growth.
- Get professional advice
Seek professional advice from financial advisors to help you make informed decisions about retirement planning. Such professionals have expertise in various investment options, financial products, and tax laws that can help you optimize your retirement savings and benefits.
Also Read: 4 Best Financial Tips for Young Adults
Retirement planning ensures financial security and peace of mind during retirement. Retirement benefits schemes in Kenya, including defined benefit and contribution schemes, provide retirees with financial security, tax benefits, long-term planning, employer contributions, and inflation protection.
To adequately plan for retirement, you should start early, determine your retirement needs and goals, consider different investment options, create a budget, take advantage of tax benefits, and seek professional advice.
With proper planning and preparation, you can achieve a comfortable retirement and leave a financial legacy for your descendants.
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