FEATURE ARTICLE

Chamberlain S. Peterside, Ph.DWednesday, January 5, 2005
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New York, NY, USA

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DEFINED-CONTRIBUTION PENSION SCHEME
...A NEW DAWN IN LONG-TERM WEALTH-ACCUMULATION FOR NIGERIAN WORKERS


�Long Time Coming

fter much bickering between organized labor and the government, and with little fanfare a new pension reform era was ushered into Nigeria mid last year. The full impact of this new scheme cannot be totally captured in one essay. It is also still early for Nigerian workers who historically have been used to a guaranteed lifetime pension and gratuity (albeit painstakingly and irregularly) to really comprehend the long-term benefit. It is possible that this generation might even never appreciate it.

A defined-contribution pension plan such as the one obtainable in the US was recently introduced in Nigeria - if successful, it is capable of transforming both the capital market and the Nigerian economy at large with over 600 billion Naira (about $4,5 billion) projected to accrue annually from the contributions. Under the new dispensation, workers are now mandated to contribute up to 7 percent of their gross income (before taxes), withdrawn at source, like it or not. While employers would match the contributions up to 15 percent of gross pay. This contribution will be held in separate accounts and invested on behalf of the employee in a basket of securities by pension managers. The investment grows on a tax-deferred basis.

For starters, both the United States Social Security Scheme and ERISA (Employee Retirement Income Security Act) were the aftermaths of a very bitter experience during the great depression, when people had no safety nets. Since the enactment of these crucial programs, America is yet to experience such harsh times comparable to the great depression and retirement planning has become an industry by itself.

American workers have become part and parcel of the ownership society; with over 50 percent of US households (as opposed to less than 3 percent in Nigeria) owning stocks, mutual funds and bonds according to published statistics, invested through so-called 401(k), 403(b) Plans, Individual Retirement Accounts (IRA), Simplified Employee Pension (SEP) and Savings Incentive Matching Plan for Employees (SIMPLE IRA). The US mutual fund and pension fund industries on the other hand have gained tremendous momentum over the last 40 years thanks to accumulated retirement contributions.


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�Power of Compound Interest
The National Provident Fund (NPF) in which every employee in the formal sector contributed part of his or her salary has been in existence in Nigeria for a very long time now. Pension schemes funded by government parastatals and private organizations have also been functioning for a long while. But the common thread missing had been that, the funds where not appropriately invested, if at all. Which has exacerbated the current pension crises.

Unfunded pension liability is estimated to top 1 trillion Naira (about $8,0 billion). Ex-service personnel and retired civil servants clamoring to receive their pension benefits have become a cynosure in Abuja and most state capitals in Nigeria and a serious blemish on the nation's moral integrity. All this could be a thing of the past if in the long-run workers are made to bear some direct responsibility for their future well-being. It is to the credit of Fola Adeola's pension reform committee that such a framework could be developed in Nigeria.

It is often said in the world of investing that "time is of the essence". One of the proven avenues for building wealth is not only to spend less than you earn, but also to pay yourself first by setting aside some part of your income no matter how small in a long-term savings plan and letting it multiply. There is an age-old maxim that "little drops of water make an ocean". Even the renowned Mathematician Albert Einstein considered compound interest "the greatest invention of all time".

By the simple process of unconsciously earmarking small portions of their income for the rainy day, workers could be stepping into a whole new world of opportunity and relative financial security enjoyed in advanced and even developing countries like Chile, that has made a huge success of this scheme. It is no surprise that people over the age of 55 - 60 years in developed countries are relatively well-off than other demographic groups.

According to Allan Murray of the Wall Street Journal, a 25-year-old in the US who saves $50 per week at 8 percent compound interest will accumulate over $750,000 by the age of 65. By contrast, a 35-year-old who saves the same amount at the same interest rate will have only $320,000 at retirement. (Visit www.Mycompletefinance.com, click on financial calculators for more insights). On the average most people would require 70 to 80 percent of their current income to retire comfortably.

Recent statistics show that nearly 60 percent of Nigerians live below the poverty line and subsequently can hardly afford three square meal and decent shelter, talk less of saving money. With widespread investor apathy and mistrust of the banking system, little wonder why most Nigerians would rather stash their meager savings under the mattress, or spend it outright than have someone else spend it for them. This partly explains the high propensity for ostentation by few people who can actually afford to save money. Mind you, most of these expenses are channeled to satisfying a taste for imported basic consumer goods ranging from clothing to food from Europe, Asia and America. You figure the domino effect on the economy.

�The Nigerian Factor
A host of attendant problems are bound to arise, especially bearing in mind the Nigerian factor. In my opinion, none of these problems could be disastrous enough to derail such a lofty program. Some questions still begging for answers are:

�Cost Benefit Analysis
These issues must be squarely addressed (and we would try to do so in subsequent essays) to enable workers adequately reap the long-term benefits of their hard-earned money. For now, here are some salient benefits of this scheme to the workers and society at large are:

  1. Mandatory contributions by employees would become a blessing in disguise - it would virtually be an automatic forced savings plan in a country with dismal savings culture and penchant for frivolous spending - for burial ceremonies, chieftaincy title, owambe parties etc. The free will to spend every bit of earnings while gainfully employed would practically be eliminated, as people become more self-reliant. If these contributions are well invested, it could translate into a substantial amount of retirement nest egg for most Nigerians.

  2. The matching contributions by employers, could add up to a lot of money too over the long haul. It would incentivize workers to save more, retain control of funds in their separate accounts that would be administered by independent managers with statutory authority, regulatory oversight and fudicial responsibility to grow the assets and distribute funds to the owner (the employee) without undue interference by the employer.

  3. The fact that "what you sow is what you reap" would make people accountable for their future well-being, rather than overly relying on their children, and relatives for subsistence at old age. The continued recycling of veteran politicians or the temptation to embezzle public funds while on active duty is a direct result of the lack of reliable safety nets, through which public servants can live a comfortable and fulfilling lifestyle upon retirement. The country is littered with erstwhile civil servants, ex-service men and private sector employees who are unable to cater to their needs after several years of illustrious service to society. If all goes well, 20 to 30 years from now, this new scheme would almost guarantee that Nigeria wouldn't have a generation of neglected senior citizens living in abject poverty and penury.

  4. This large pool of funds would help bolster the capital market, create large sums of investible assets for the housing industry, and mobilize long-term financing for small and medium enterprises (SME), which would in turn propel economic progress in the country.

The clear and imminent danger for the program could be the threat of inflationary tendency in an uncoordinated economic policy environment and unstable political climate. Inflation is capable of decimating these retirement savings/investments over the long-haul, unless the fund managers are astute enough to deliver rate of returns that could outpace inflation or appropriate macro-economic instruments could be utilized to tame inflation. Then again, one would hope that the prevailing political condition permits.

�No More Nirvana
It is practically impossible to convince all naysayers on the potential long-term impact of such a program in Nigeria, just as it will be wrong to predict that everything would be smooth-sailing from now on. The new defined contribution scheme will be a far cry from the outmoded defined benefit plan. Realistically, in a new global paradigm those who believe that government or employers will guarantee their future are living in Nirvana.

With the fall of the iron curtain the trend even in western countries is shifting and job security is now an aberration rather than the norm. Experience in those countries attest to the wealth effect of regularly saving for the rainy day. Gradually but surely Nigerian workers could begin to sow the seeds of future economic prosperity for the society as well as building financial security for themselves and their family.

Chamberlain is the Founder & President of New Era Capital Corp. and MyCompleteFinance.com, a New York based financial services group. He was previously a Financial Advisor in the Global Private Client Group, of Merrill Lynch.