RETIREMENT PLANNING PROCESS

OBJECTIVES

Retirement planning process

Zimbabwean corporate planning schemes (Defined, contribution, hybrid)
Zimbabwean individual retirement planning schemes
Lessons from developed countries

Retirement Planning

Retirement planning is the process of setting goals for your retirement years and actions and
decisions needed for achieving those goals. It includes identifying sources of income, estimating
expenses and cash flows, implementing a savings program, determining time horizon, assessing
risk tolerance and doing estate planning.

Retirement planning process is a continuous process, that evolves through the years which means
portfolios should be rebalanced and estate plans updated as needed. Thus it’s advisable to start
planning for retirement as soon as you can take advantage of the power of compounding

RETIREMENT PLANNING PROCESS

The retirement planning process is made up of six steps and for this process it is advisable to work
with an advisor to help you effectively plan. The steps are as follows:

Step 1: Understand your financial situation and what you want your retirement to look like
Planning for retirement starts with thinking about your retirement goals and how long you have to
meet them. Having accurate retirement spending goals help in the planning process as more
spending in the future requires additional savings today. Arrange your goals into short, medium
and long term goals. It’s also critical to assess your current personal financial picture that is your
assets, liabilities, income, and expenses will be considered in planning your future retirement.
Step 2: Identify how much money you will need and where it will come from
Your retirement may cost more or less than you think depending on the goals and priorities you
identified in Step 1. Your current age and expected retirement age create the initial groundwork of
an effective retirement strategy. The longer the time between today and retirement, the higher the
level of risk your portfolio can withstand for example you are young and have 35 plus years until
retirement you can afford to invest in risky assets. Then you need to look at the types of retirement
accounts that can help you raise the money to fund your future. As you save that money, you have
to invest it to enable it to grow. Retirement income comes from a variety of sources that include
pensions, social security, registered retirement savings plan, and other investment portfolios, thus
it is important to invest in a well-diversified portfolio. Additionally you need to invest in
investments that gives returns that outpace inflation so you can maintain your purchasing power
during retirement.
If you have a financial advisor he can assist u estimate your expenses and anticipated income in
retirement, and help you factor in variables such as:
• How inflation might affect your expenses
• Whether you are spending too much too soon
• If you are planning adequately for increasing healthcare costs
• How to balance spending in retirement and the need to support your family over the longer term

Step 3: Develop appropriate strategies to prepare you for retirement

Understanding key issues will help prepare you for a retirement with fewer financial surprises. For
example, how would you like to retire? What are your projected expenses and income sources?
Do you know what your assets and debts are? This information will also help your Advisor
develop expense, investment, and income strategies, as well as suggest tax-saving products, that
could potentially make your assets last longer or allow you to achieve your desired retirement
lifestyle sooner. For example, delaying retirement, working part time for a few years, or saving
more today can help bridge any financial gaps in your retirement plan.

Step 4: Review your written retirement plan presented by your Financial Advisor
Your Advisor will present and review a detailed, written retirement plan with you, including
strategies to help bring you closer to your goals. The specific strategies in your plan will be unique
to your situation, reflecting your priorities and objectives. Your plan will act as a guide and
provide benchmarks we can refer to as we review your progress towards your goals in the years
ahead.

Step 5: Put your plan into action

Now that you and your Advisor have reviewed and discussed your retirement plan, your Advisor
will work with you to implement the strategies you have agreed upon. For example, your Advisor
might recommend a tax-efficient income solution, such as a Registered Retirement Income Fund
or Tax Free Savings Account.

Step 6: Monitor and adjust your plan on an ongoing basis

Once your plan has been implemented, you can feel confident that the strategies are now in
progress but there is need for continued monitoring of the portfolio investments to ensure that the
investments can meet your retirement objectives and also taking into account changes in your life
. For example, with the help of your advisor you may need to:
 Adjust your investment mix so it becomes more conservative as you approach retirement
 Consolidate investments to ensure you have the appropriate investment mix, reduce
ongoing fees, and give you a full picture of your investments
 consider all the options if an early retirement package from your employer is offered to
you
 Develop a plan to convert your investments into a tax-efficient cash flow at retirement
These regular reviews also help ensure that you are taking full advantage of any new opportunities
that become available and you are guarding against threats that may come.

QUESTION
Why is retirement planning important to an individual and explain why age is a critical factor in
retirement planning

What is a Retirement Corpus?

The total accumulated funds from all sources of investment (including terminal benefits like
Gratuity, Pension Fund from the employment source) that become available to an individual on or
around the retirement date is known as the retirement corpus. This accumulated fund should be
invested & utilized in such a way that, besides taking care of the daily needs, it should suffice for
any more contingencies not only till the survival of the individual but also would cater to the needs
of his/ her spouse till he/ she survives.

How much should be the corpus?

Retirement corpus varies from individual to individual depending upon one’s income & ability to
save and standard of living one intends to maintain post- retirement. It becomes difficult to
compromise on the standard of living and accordingly one need to target for the retirement corpus.
An Adult human life is divided into parts i.e. 1. Earning phase & 2. Spending phase. In the earning
phase an individual earns and saves; while in the spending phase, his/ her accumulated savings are
utilized for his/ her needs. There are two different methods to arrive at the retirement corpus are;
a. Expenses method & b. Income placement method as follows:
Expenses Method
i. Expenses at the current is arrived at by taking the inflation and calculated at the retirement
date ( age)
ii. Retirement corpus is arrived at by taking the inflation adjusted expenses as expenses for
the remaining period (life expectancy- retirement age) at real rate of interest.
iii. Monthly/ yearly savings to achieve the target corpus during the earning phase is calculated
at the nominal rate of return. (Steps 1 & 2 are part of the spending phase while step 3.
pertains to the earning phase.)

Let us understand the calculation of retirement corpus and savings needed for the same under the
Expense method through a simple illustration as given below: Example: Mr. X who is 40 years old
spends annually Rs.700 000 towards his household expenses. He expects to retire at 62 years.
During this period inflation is expected to be on an average 6% p.a. He wants to cover 35 years’
living expenses for self and spouse. If the inflation in the post-retirement period moderates to an
average of 4% p.a. and he expects to generate a return of 7% from his accumulated corpus, what
corpus should he target for a comfortable retirement?
Solution
Current age of Mr. X 40 years
Retirement age 62 years
Current household expenses 700,000 Rs . pa
Inflation during the pre-retirement phase 6.00% p.a.
Expenses expected on retirement 2,522,476 Rs. p.a. 700000*(1+6%)^(62-40)
Return expected from investing retirement corpus 7.00% p.a.
Inflation expected during the post-retirement phase 4.00% p.a.
Living expenses required for the period 35years
Corpus to be accumulated on retirement 56,715,821 Rs PV((1+7%)/(1+4%)-1,35,-
2522476,0,1)

Practice Questions
Question 1
A person at age 57 has accumulated Rs.5 million towards retirement funds and opts for premature
retirement. He purchases an immediate annuity for a total term of 20 years, a fixed monthly amount
for the initial period of 10 years and a provision to double the monthly amount in the second 10-
year period. If the minimum yield guaranteed in the annuity is 8% p.a., what monthly amount he
is expected to receive in the subsequent 10-year period?

Question 2
A, 40 years, earns a gross monthly salary of Rs 50000. His monthly household expenses is Rs.
20000. Calculate his retirement corpus and monthly savings needed to achieve the targeted corpus,
considering he maintains the same living standard post- retirement, his retirement age is 60 years,
and his life expectancy is 85 years, inflation rate for the total period may be assumed to be 6% and
return on investment be 9%.

WHAT IS A PENSION?
A pension is defined to be a benefit paid to an employee who retires from his or her job after reaching a
prescribed age of retirement. When this benefit is paid regularly and periodically from the time the
employee leaves his job until death, the pension benefit is called an "annuity." Alternatively, if a single
payment is made upon retirement, it is called a "lump-sum benefit." Finally, a payment made to a worker
who leaves the company before reaching retirement age is not a pension; this we term a "severance
payment." The defining feature of a pension is therefore that it is paid only after the beneficiary has grown
old and retired.

A stream of income is usually paid when one attains retirement age, however it can also be paid
to a dependent upon the death of a member of the pension fund. In other words, a pension is a type
of insurance against old age, reduction or loss of income to a member of the pension fund.

WHAT IS A PENSION PLAN?

It is an arrangement under which an employer and/or an employee make contributions into a pool
of funds set aside for a worker's future benefit. The pool of funds is invested on the employee's
behalf, and the earnings on the investments generate income that is used usually used to pay a
pension upon retirement, death or termination of employment or upon the occurrence of such
events as specified in the law or the document establishing the pension scheme. It has favorable
tax treatment compared to other forms of savings.

TYPES OF PENSION SCHEMES

Defined Benefit Plan

1. A Defined Benefit pension plan promises to pay you a certain amount of retirement income
for life.
2. The amount of your pension is based on a formula that usually takes
into account your earnings and years of service with your employer.

3. In most plans, both you and your employer contribute.

4. Your employer is responsible for investing the contributions to ensure there’s enough money
to pay the future pensions for all plan members.

5. If there’s a shortfall in the money needed, your employer must pay the difference. And
sponsor may cream –off plan if it out grows target values.
Defined Contribution Funds

 With a Defined Contribution plan, contributions are guaranteed, but retirement income is
not.

 The risk is borne by the employees

 Usually, both you and your employer may contribute to the plan. Your employer may
match some of the contributions you make.

 Employees are responsible for investment choices to grow their savings, thus they have a
greater say on how the plan is run.
 The amount available for your retirement depends on the total contributions made to your
account and the investment returns this money earned.
 The assets of this plan are never touched by the sponsor ie sponsor cannot make any
withdrawals from plan even if it gets to levels where it is perceived to have over –grown
by market standards

 At retirement, you can use the money in your account to generate retirement income.
You can be done by:

o buying an annuity from an insurance company, or

o Transferring your savings to a locked-in retirement income fund (LRIF) or
similar income fund designed specifically for pension savings.

Questions
1. Explain the advantages and disadvantage of defined benefit plan to both the employer and the
employees
2. Explain the advantages and disadvantage of defined contribution plan to both the employer and the
employees

Hybrid Pension Plan

“Hybrid” is often used to refer to any retirement plan that combines some elements of a traditional
defined benefit pension plan and a defined contribution plan with an individual retirement savings
account to which the employee and employer contribute money. In this brief, we focus on the plan
design known as a side-by-side hybrid, which combines a defined benefit (DB) based on the
employee’s final average salary with a separate defined contribution (DC) savings account.
Separate DB and DC portions in a hybrid plan provide a smaller benefit than they would in a stand-
alone DB or DC plan, but when combined; they can provide a comparable level of total benefits.

Question

Discuss the factors that are considered in designing a Hybrid Pension plan

Terms Pension Fund Management

Vested Pension rights

Where an employee has rights to receive pension benefits even if he/ she leaves company before
retirement.

Non –Vested Pension rights

Employee does not receive pension benefits if he leaves company prior to retirement. Definition:
A non-vested pension plan is one in which the employee has not completed the required years of
creditable service in order to earn the right to receive benefits under the terms of the plan. Most
pension plans require members to achieve a set number of years of creditable employment before
being entitled to pension benefits under the terms of the plan (i.e. 3 years, 5 years, 10 years, etc.).
Vesting occurs when the employee completes the number of years of service required to receive
benefits under the plan at some point in the future.

General Discussion:

Non-vested pensions, though not entirely earned, represent a form of deferred compensation for
service performed over the course of a number of years. Although vesting occurs on one day, it is
not logical to assume that the pension benefit for all years of employment up to that day was
entirely earned on that one day. For example, an employee’s benefit may vest after completion of
5 years of service, however, the employee could not achieve vested status without being employed
for the 4 years and 364 days prior. Therefore, part of the value of the vested pension after 5 years
must have been attributable to the first 4 years and 364 days of employment.
Deferred Vesting

Pension rights non-vested for the first few years and become vested thereafter.

Portable Plan

That which an employee can carry from one employer to the other.

Parties to Pension Fund Schemes

 Sponsoring company: This is always the employer. The employer is obliged to allocate/
set aside a certain amount of profits or capital towards building a pool of pension funding
resources.
 Trustee: The pension fund is run by a trustee. The trustee comes into play to manage the
conflict between employees and employer. Employees usually are not comfortable to have
the pension scheme being overseen by employer nor are the employer comfortable to have
employees running the scheme. An independent board of trustees is then enacted to run the
scheme.
 Auditor: The auditor is interested among other things to check if there is abuse of funds.
Fund managers more often than not are involved in front running which results in pension
funds buying assets at higher prices. Audit also makes sure that all transactions abide to
the set policy.
 Fund Manager
 Regulatory Authority

What is the structure of Zimbabwean Pension Industry Like?

The Zimbabwean Pensions Industry may be categorized into four main classes, which are:

a) Occupational Pensions Schemes

These funds are set up by employers for the benefit of their staff. The majority of these are
DC schemes. Occupation pensions fund can either be self-administered or insured funds.
The distinguishing feature between the two is that for self administered funds, the assets
of the fund are registered in the name of the particular fund while for an insured fund,
assets are registered in the name of the insurer who makes certain promises to members of
the fund. The trustees of the self-administered funds are ultimately responsible for the
investment decisions and performance of the fund. There are two main forms of self-
administered funds. That is those that own and control their respective administrative
structures; and those that outsource administration services from life insurers or
professional pension fund administrators. Such funds can be umbrella schemes that bring
together various sponsoring employers under one fund. These are mostly industrial based
schemes that are formed through the collective bargaining process.
Insured funds are usually small funds whose assets are pooled together and invested in the
name of the life insurance company that administer them. Investment decision are done on
behalf of the funds by the insurance company.

b) Personal Pension Plans (Individual Schemes)

These are pension plans that are set up by life insurers targeting individual members not
necessarily tied to any employer or any formal setting. Such schemes are ideal for those in
the informal sector. It aims at ensuring a minimum standard of living for all pensioners.
This is either done through a universal or basic flat rate pension, a minimum pension (in
earnings related PAYG schemes), or provisions in the social security system available to
all citizens.

c) Public Service Pension Scheme

This is a pay-as-you–go defined scheme that caters for civil servants. The scheme was
established by an Act Parliament. This scheme is not regulated by IPEC.

d) National Pension Scheme

This is a compulsory pension scheme for all those who are formally employed, the scheme
is administered by the National Social Security Authority (NSSA) and accordingly is
commonly known as “NSSA Pension”. Just like the public service pension scheme it,
NSSA is currently not under the supervision of IPEC.
Questions

1. What are the challenges faced by Zimbabwean Pension Scheme in ensuring comfortable
retirement for individuals when they retire?
2. What lessons can Zimbabwean pension providers learn from developed countries to
improve livelihoods when people retire in their old age