A pension scheme can be structured either as a defined benefit or defined contribution scheme or a hybrid scheme (combination of both defined benefit and defined contribution scheme).
Ghana’s 3-Tier Pension Scheme consists of both defined benefit and defined contribution scheme.
A defined benefit scheme is a pension system where the benefit paid to members depends on a predetermined formula.
The quantum of benefit is dependent on key inputs of the formula which includes the average of the three years (36 months’) best salaries, age at retirement and the pension rights accrued from the perspective of the National Pensions Act, 2008 (Act 766) as amended.
A defined contribution scheme on the other hand has no specific formula for determining the benefit.
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The quantum of benefit depends on the amount contributed and investment returns on the funds.
Time value of money is very important as any delay in payment of the monthly contributions affects the final accrued benefit.
Ghana operates a contributory 3-Tier Pension Scheme structure comprising a 1st Tier defined benefit publicly managed by the Social Security and National Insurance Trust (SSNIT) and 2nd and 3rd Tier schemes as defined contribution schemes privately managed by licensed trustees.
As explained earlier, the benefit under a defined benefit scheme as predetermined and included in the formula is what is referred to as Pension Right.
Pension right refers to right acquired by a contributor by reason of the number of months or years that the contributor or worker has contributed into the scheme.
It gives the worker the proportion of pension accrued during his/her working life, using the number of months of contributions.
Under the First Tier Scheme of the 3-Tier Pension System, if a worker contributes for 180 months, the worker automatically accrues 37.5 per cent or 0.375 as his/her initial Pension Right.
This translates into 15 years of contributing into the First Tier Basic National Social Security Scheme managed by SSNIT.
Additionally every 12 months of contributing gives the worker 1.125 per cent resulting in a monthly pension right accrual of 0.09375 per cent (ie 1.125 divided by 12) or 0.0009375 (ie 0.09375 per cent divided by 100).
Assuming a worker works for 30 years, which is 360 months, his/her pension right is calculated as follows:
Pension Right = 37.5 per cent + (360 months-180 months) x 0.09375 per cent
= 37.5 per cent + (180 months x 0.09375 per cent) = 37.5 per cent + 16.875 per cent = 54.375 per cent or 0.54375
Therefore for 35 years (420 months) of contributing into the scheme, the worker gets = 37.5 + (420 months -180 months) x 0.09375 = 37.5 + (240 x 0.09375)
Pension Right = 37.5+22.5 = 60 per cent or 0.6
The above illustration indicates that if a worker starts working at the age of 30 years he/she is likely to get less than 60 per cent, while if that person had started working at age 25 or below, he/she is likely to get 60 per cent or more of pension right.
However, under the 1st Tier of the 3-Tier Pension Scheme, a worker can only accrue a maximum pension right of 60 per cent.
This also indicates that the more years you work or contribute into the 1st Tier mandatory scheme, the more pension right you accrue.
We must, however, bear in mind that having a higher pension right of 54.375 or 60 per cent may not necessarily result in higher pension benefits, though it has a significant impact in determining the benefit.
This is because other factors such as age reduction factor for those who retire earlier than the mandatory retirement age of 60 years and an average of the best three years annual salary all come into play in determining the final pension benefit.
The writer is the Corporate Affairs Officer at the National Pensions Regulatory Authority