One of the significant achievements of former President Obasanjo was the Pension Reform Act of 2004. It completely transformed the pension industry from one that was comatose with insignificant assets to a vibrant and growing one with N6 trillion in funds under management at the end of September 2016. Thanks to the reform, over 7.3 million Nigerians now have Retirement Savings Accounts (RSA).
The Act was reviewed and revised in 2014 and is referred to as the Pension Reform Act 2014. Under the revised Act, the contribution of employers increased from a minimum of 7.5% to 10% of the total of basic pay, housing, and transport allowances. The contribution of employees increased from a minimum of 7.5% to 8%.
An important feature of the 2004 Act that was maintained in the revised 2014 Act was the provision for additional voluntary contributions. Employees are allowed to make extra voluntary contributions above the stipulated 8%.
If you are among the fortunate Nigerians to have an RSA, here are 4 reasons why you should make additional voluntary contributions to increase your pension savings.
Voluntary contributions are tax-free
All voluntary contributions are deductible for tax purposes. This means you pay no tax on the part of your salary that is deducted as the voluntary pension contribution. For example, if your effective tax rate is 15%, you pay nothing on the tax-free voluntary contribution. You will be hard pressed to find an investment that returns 15% with such ease. In addition, the incomes on your voluntary contributions are also tax-free. This is, therefore, a great opportunity to save in a tax-efficient manner.
You can withdraw your voluntary contributions anytime, however, you will be liable to pay taxes on the income earned if you withdraw the funds within five years of making the voluntary contributions.
Automatic and simple process to save
It is very simple to set up additional voluntary contributions to add to your regular pension contribution. All you have to do is to instruct your employer to automatically deduct the funds from your salary through the payroll system. Once done, no further action is required from you. And since the funds are not credited to your bank account, you are not likely to miss the cash. The combination of simplicity and automation means you are far more likely to stick to making the voluntary contributions compared to a manual monthly transfer to your savings account.
Long-term compound growth
Another advantage is that the voluntary contributions will enable you to enjoy the long-term compound growth of your savings. This is especially beneficial if you are young with lower pay but decades of employment ahead of you. The additional voluntary contributions no matter how small will grow into something significant thanks to the power of compounding. For example, an additional N10,000 monthly contribution over 20 years yielding 10% per annum will result in final savings of N7.66 million. Meanwhile, N20,000 monthly contribution over 10 years at the same 10% will result in final savings of N4.13 million. Although in both cases you contributed the same N2.4 million, the power of compounding means starting early with a smaller amount yielded an extra N3.5 million.
Low pension savings
Although the total pension assets have grown to N6 trillion, the average pension savings per person is a mere N820,000. The implication is that for most RSA holders, the 18% mandatory contribution will likely prove inadequate in providing a decent pension when they retire. The voluntary contributions, therefore, provide a good opportunity to increase pension savings and ensure higher income on retirement.
The year 2016 has been one of heightened economic anxiety for many of us as the Nigerian economy contracted for the first time in decades. Planning ahead and improving your pension savings through additional voluntary contributions will go some way in reducing the anxiety in 2017 and beyond.