Why defined contribution schemes are future of retirement planning

Early pensions, with their origins dating to the Industrial Revolution, were defined benefit plans by employers as part of worker welfare. By the late 1990s, countries such as Australia and Chile had implemented the shift from defined benefit schemes to defined-contribution pension schemes, informed by economic pressures and demographic changes.

Increasing life expectancy and declining birth rates made it increasingly difficult for employers to sustain the financial commitment of defined benefit scheme plans.

Kenya is running the two models in the administration of public pensions. The defined benefits and defined contribution approaches differ in terms of how benefits are financed and determined.

The retirement benefits offered by defined benefit schemes are based on a formula that takes into account an employee’s earnings and length of service. On the other hand, benefits under the defined contributions approach are determined by the amount contributed and the accumulated earnings on the contributions.

Retirement benefits for public sector employees aged 48 and above, as well as for retirees, are administered under non-funded defined benefit schemes and financed on a pay-as-you-go basis. Over the years, these pensions have increased exponentially, reaching unsustainable levels.

Cognizant of these limitations, the government implemented a defined contribution scheme in January 2021. Under this new system, employees and the government contribute. The amounts are remitted to a dedicated fund, the Public Service Superannuation Fund.

Kenya is drawing on lessons from other jurisdictions when implementing these reforms, aiming to alleviate poverty in old age and ensure a smooth transition from active service into retirement.

This model not only enhances retirement security but also stimulates the broader economy by channelling funds into diverse investment avenues.

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The transition to a defined contributory approach for public sector employees who were below 45 years as at January 2021 began with a membership of 330,000 employees, drawn from the National Police Service, Kenya Prison Service, the National Youth Service, Teachers employed by the Teachers Service Commission and civil servants.

The number of employees contributing to the new scheme has increased to 505,000 to date, in keeping up with the changing composition of the public service workforce.

At present, these members contribute 7.5 per cent of their basic salary, with the Government contributing 15 per cent in respect of each employee.

The conversion to DC Schemes comes along with stricter regulation and supervision to enhance scheme governance and guarantee the protection of members' interests.

The DC approach also allows members to make additional voluntary contributions to achieve their retirement dream.

Through this approach, employees can assess their progress towards retirement goals and potentially choose to make enhanced voluntary contributions beyond the mandatory amount.

These additional contributions have the potential to significantly increase accumulated savings and translate into larger retirement payouts.

Ngumbo Njoroge is the Head of Corporate Communication, Public Service Superannuation Fund