What is your replacement ratio?

Each member of a pension plan or retirement scheme is legally entitled to a benefit statement annually, to be provided within four months of the end of the financial year end.

Additionally, the Pensions (Superannuation Funds and Retirement Schemes) Act and its accompanying regulations apply a minimum standard to which all benefit statements should conform, including name of the member and sponsor, taxpayer registration number, pensionable salary, normal retirement age, basic and voluntary contributions made by the member, projected pension at retirement, and accrued benefit to date.

The statements detail the monies accumulated by an individual in a pension plan or retirement scheme, but one bit of information, which is most relevant, is sometimes missing: the replacement ratio (RR).

The RR is a projection of the pension you will receive in retirement expressed as a percentage of your projected final salary you were earning immediately before retiring.

Simply put: if your projected pension at retirement is $300,000 per annum and your final salary before retiring was $500,000, your RR is 60 per cent - that is, $300,000 divided by $500,000.

actuarial projections

An RR utilises actuarial projections for long-term invest- ment rates of return, an assump- tion of continued membership to retirement date, and projected salary increases to the date of retirement.

While the use of each variable will differ depending on whether the pension plan is a defined benefit or defined contribution scheme, the use and applicability remains relevant.

The RR does not represent your actual pension but is merely an indicator to provide persons with an idea of their financial standing at retirement.

The need to calculate and provide the RR on pension statements is most critical for different reasons. Many persons are not aware of the benefits that they will accumulate to retirement,leaving them vulnerable at that delicate stage in their lives.

For example, suppose 'Woman A' retired today and is now being informed that her pension will replace only 40 per cent of her final, salary. Undoubtedly, she would become disheartened knowing that based on her expenses she would not be able to adequately provide for herself in retirement.

However, 'Woman B', who is retiring in the next 20 years, knowing that her RR is 40 per cent, can commence taking the steps to improve that percentage.

On reviewing their RR, members can assess their ability to retire and maintain their standard of living. A member receiving a low RR should not be discouraged but use the information as a planning tool to better prepare for retirement.

Unfortunately, while members close to retirement will be challenged to improve their RR in the short time to retirement, they will have the time to make personal changes in their financial standing. Fortunately, the law now allows persons to delay retirement for an additional five years after normal retirement date, with the approval of the employer and trustees towards accumulating a higher pension benefit and RR.

don't be discouraged

Persons with a low RR need not be discouraged, as there are steps to be taken to improve your financial standing at retirement.

Persons are encouraged to maximise their pension contribution, as the more you contribute to your pension plan - both the compulsory and voluntary portion - the higher your RR will be.

Critically, members are also encouraged to maximise their voluntary contributions as this provides an additional top-up benefit on your basic pension and contributes to a higher RR.

Long-serving pension-plan members will invariably have a higher RR. For that reason, when terminating employment, seek to port your accumulated pension benefit and most important, pensionable service to the pension plan of your new employer, or to an individual retirement account.

And, maximise the investment returns. This is especially important for defined contributions plans, as the pension at retirement is also dependent on the investment performance of the pension plan. Additionally, investment returns above that assumed by the actuary provide the trustees of defined benefit plans to periodically offer their pensioners an increase in pensions.

Not all pension providers compile and report this information, but it should be adopted by all stakeholders, as it addresses relevant issues such as adequate planning and preparedness of retirement. Senior executives, human resource managers and trustees should ensure that members are made aware of their RR, as this feature is an important planning tool.

Rezworth Burchenson is managing director of Prime Asset Management Limited. rburchenson@primepensions.com