Pensions have many advantages as an investment savings plan for your retirement years.
By using a variety of investment methods, pensions are designed to provide people with more income than they could save by themselves during their lifetime.
Before we get into the details of how that works, we’d like to reiterate the importance of retirement savings generally – pensions or otherwise.
Many people are not saving nearly enough to give them the standard of living they hope for when they retire.
The estimated income required at retirement is around 70% of your current income. For example, if you currently earn $60,000 per year then you should plan to live on about $42,000 per year in retirement. This means you would need over $1.2 million saved at retirement. This example assumes you are retiring at age 65 and live until 95, which is a reality for many people.
So how can a pension help you achieve this?
During the accumulation phase, the pension fund will tend to increase in value because of two things. First, it will increase because of your employer’s matching contributions made into the fund, which is like getting free money. Second, the investment value will increase over time due to returns generated by the assets, such as stocks and bonds, that are in the fund.
For example, in a pension scheme that requires annual contributions of $1,000 over 40 years, the fund’s assets will build up to $120,800 in value at retirement if the return on cumulated funds was 5% per year; but the same contributions over the same period would grow to $154,800 if the rate of return was 6%.
This simple numerical example illustrates that small changes in the return on assets can have a dramatic impact on the size of the pension fund at retirement, and hence on the pension that can be paid from this accumulated fund. In practice the returns on pension fund investments will vary every period, hence introducing some risk into the size of the pension fund at retirement, and types of pension schemes differ according to who bears this investment risk.
The basic advice with pensions is to put in as much as possible, as early as possible. If you delay saving into a pension, you will then need to contribute a higher percentage of your income to achieve a comfortable retirement. The sooner you contribute, the longer your money will have to grow as the compounding effect of investment returns can make a huge difference over the long term.
There are several benefits for those who hold pensions in the Cayman Islands.
The main benefit being that the government requires your contributions to be matched by your employer (typically 5% to reach the legislated total of 10% of your income). This essentially doubles your savings. Many companies in other countries are not obligated by law to provide pensions to their employees and those that do offer it as an employment benefit.
Additionally, your loved ones such as your spouse and children (or your named beneficiaries or estate) are eligible to receive your pension benefits after you pass.
You also have the option of making Additional Voluntary Contributions (AVCs) to your plan, which will help it grow faster. In certain circumstances these AVCs, and even a certain amount of your pension balance, may be withdrawn prior to your retirement, such as in the case of disability or to purchase a home. We would be happy to provide further details in these circumstances.