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Compounding Our Pension Problems

By Larry Gibson

Whilst we are all living longer, we must ensure we do not outlive our accumulated pension savings. In fact, this is perhaps the single greatest challenge that will confront ‘baby-boomers’ who will be retiring annually (in large numbers) over the next 20 years.

Making smart money choices over your lifetime can mean the difference between a stressful retirement and a comfortable one. So, what does retirement mean to you? Some view it as an end, while others see it as a journey or transition to another phase in life. How do you plan for retirement, and how do you know how much you will need?

Remember now, your expenses do not magically disappear once you reach retirement. As we age, our health care costs escalate, both at the individual level and at the national level.

Planning for retirement

Planning for your retirement is a personal process, as we each have our unique circumstances and should not follow a one-size-fits-all approach. A retirement plan should be based on what you envision for your life, and must take your financial situation into account.

When should you start planning for your retirement? The best possible time to start planning your retirement is while you are in the early stages of your work life. The more time money has to work, the greater the potential rewards.

Because of longer life expectancies and forced early retirements, it is quite possible you could spend almost as long in retirement as you did in the workforce. How then can you ensure that you do not run out of money when you need it most in your retirement years?

The pension challenge

There is a global problem with defined benefit (DB) pension plans, in that they are increasingly severely underfunded. A pension plan that is a traditional DB plan provides a pre-determined monthly retirement benefit to an employee based on the employee’s earnings history, years of service and age. The costs of these plans are generally funded by employer contributions into a trust fund. An underfunded pension plan is one where the known liabilities (obligation to pay future pensions) are far greater than the assets that could be used to pay those obligations.

The problem of pension plan underfunding is not just limited to large companies in the major developed economies. Recently, the Bahamian press carried stories about growing unrest at the Central Bank of the Bahamas (CB). Apparently, Central Bank management is trying to restructure pension arrangements so as to ensure a more sustainable plan going forward. It was indicated that annual required contributions to the existing DB plan exceed 20 per cent of payroll. It is said that most, if not all, of the statutory corporations including BEC, Broadcasting Corporation, BAIC and Water & Sewerage Corporation all face massive shortfalls in funded status. Newly privatised BTC also sits among the pack. Taken together, this is a most frightening situation.

Compound interest

While Einstein called compound interest the greatest invention in human history, most people fail to grasp how compound interest, time and a modest amount of financial discipline can make the prospects of a safe and secure retirement virtually a ‘slam dunk’.

Keep in mind that the best way to boost your savings is to let your money build on itself through compound interest, and if you start saving early, the benefits will be greater because compound interest is interest that is paid on both the principal and any interest from past years.

For example, if you earn a 10 per cent return on your $1,000 investment the first year, and I reinvested the money back into the original investment at the same return, then in the second year, you would get a 10 per cent return on both the $1,000 and the $100 (return) you reinvested. Over time, compound interest will allow your money to grow significantly depending upon how long you invest and your rate of return.

As deposit rates continue to decline in the Bahamas, it is likely that we will see a shift out of low yielding deposits into other investment opportunities to seek higher returns. With the long term rate of inflation around 3 per cent, fixed deposit rates less than 2 per cent are not attractive to long-term investors.

Could this be a precursor to heightened local capital markets activity? While it is much too early to say, history (in developed countries) has shown that if your investment horizon is long-term (greater than five years), you will be compensated for the additional risk you take on.

Conclusion

If you want to ensure that you can enjoy a good life in retirement, it is important that you have the right pension and investment partner working with you at all times.

Save the Date

Colonial Pensions will be hosting the world renowned, two-time Emmy Award winning financial talk show host, best-selling author and columnist, Suze Orman, on May 17 at the Melia Cable Beach Resort. Her talk will focus on ‘personal finances and retirement planning’. Stay tuned for ticket information.

Until next week…

• NB: Larry R. Gibson, a chartered financial analyst, is vice-president - pensions, Colonial Pensions Services (Bahamas) , a wholly-owned subsidiary of Colonial Group International, which owns Atlantic Medical Insurance and is a major shareholder of Security & General Insurance Company in the Bahamas.

The views expressed are those of the author and do not necessarily represent those of Colonial Group International or any of its subsidiary and/or affiliated companies. Please direct any questions or comments to larry.gibson@atlantichouse.com.bs

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