By Frank ANDERSON
An annuity is a financial product designed to provide regular payments of income to an individual during retirement.
It is a contract between an individual and an annuity provider, usually a life insurance company, in which the individual pays a premium, either as a lump sum or through a series of contributions to the company over time.
In return, the insurance company makes a series of regular payments after retirement, to the individual typically in the form of a pension.
The primary purpose of an annuity is to provide a steady stream of income during old age. Some annuities are indexed annually to account for inflation, helping to preserve the purchasing power of the income throughout the annuitant’s lifetime.
Beyond ensuring consumption smoothing over an individual’s lifecycle, annuities also mitigate longevity risk, that is the risk of outliving one’s accumulated savings. This reduces the uncertainty about how long one’s resources must last and helps ensure a minimum standard of living in retirement, thereby lowering the risk of old-age poverty.
Why annuity is important under the three-tier pension scheme
The main objective of Ghana’s three-tier pension scheme is to ensure retirement income security for workers, thereby reducing old-age poverty. One key way to achieve this goal is through the regular or periodic payment of pensions.
Under the three-tier pension scheme, the first-tier Basic National Social Security Scheme (BNSSS) provides monthly pensions to retirees who meet the minimum qualifying condition of 180 months of contributions. This benefit is guaranteed for 15 years but paid for life.
However, not all contributors qualify for this monthly benefit under the three-tier pension scheme. Those who do not qualify are instead paid a one-off lump sum by the Social Security and National Insurance Trust (SSNIT), with no provision for monthly pensions. The second-tier occupational pension scheme, the third-tier voluntary provident fund and the personal pension schemes are designed to pay only lump sum benefits to the members and their beneficiaries.
Given the importance of regular income in reducing poverty and ensuring consumption smoothing throughout the life of the worker, the National Pensions, 2008 (Act 766), stipulates that a portion of the benefits from the second-tier and third-tier schemes should be used to purchase an annuity from a life insurance company.
This annuity is guaranteed for 15 years and continues for the rest of the holder’s life if the person is alive after the guaranteed period, just like in the case of the first tier.
Specifically, for individuals who do not qualify to join the first-tier basic scheme and whose full 18.5 percent contributions went to the second-tier occupational pension scheme, the law provides that 75 percent of their accrued benefits must be used to purchase an annuity.
For contributors under the third-tier group and personal pension schemes, who are primarily informal sector workers, the accrued benefits in the retirement account should be used to purchase an annuity guaranteed for 15 years but also paid for life.
This provision is to ensure that every contributor under the three-tier pension scheme receives lifelong income on retirement. This is crucial in ensuring that every Ghanaian worker gets the opportunity to enjoy a pension, whether in the formal or informal sector.
Despite its benefits, many people do not appreciate the importance of annuities and prefer to receive their pension benefits as lump sums. These lump sums are often spent quickly, and many retirees later face financial hardship. Some do not even remember what they used the money for.
This challenge mirrors early experiences under the SSNIT scheme, when only a lump sum benefit was paid to the members of the scheme. Pensioners often exhausted their benefits within a short time and ended up in poverty.
This situation led to the pensions reform of the early SSNIT scheme, which eventually introduced the monthly superannuation benefits.
Even though the law requires that 75 percent of the accrued benefits of those above 45 years as well as benefits accrued in the retirement account by informal sector contributors under the group and personal pension schemes be used to purchase an annuity, this provision is often ignored. Instead, the full accrued benefits are paid directly to the contributors, many of whom are unaware of the legal requirement to purchase the annuity.
The way forward
To ensure that contributors use part of their accumulated benefits to purchase annuities as mandated by law, the insurance industry must invest in extensive awareness campaigns to educate Ghanaians about the importance of annuities.
Many people are unaware of what an annuity is and how it works, which makes them less likely to purchase one. Additionally, industry regulators and players must develop the annuity market into a viable and attractive investment option.
This includes creating solid investment strategies to manage annuitants’ funds and ensure timely, consistent payouts to build public confidence and trust in the product.
Again, trustees should be empowered to directly transfer the portion of funds earmarked for annuity purchases (e.g., 75 percent of accrued benefits of those above 45 and accrued benefits in the retirement account of informal sector workers) to the selected insurance company, rather than disbursing it to the contributor.
This will ensure that the funds are used for their intended purposes in ensuring retirement income security.
Conclusion
Annuities play a critical role in retirement planning by ensuring that individuals have a reliable income stream for life. They help address key retirement concerns such as financial security and longevity risk, due to the continuous increase in life expectancy. Annuities should be part of a broader retirement planning strategy that considers personal goals, health, risk tolerance and other income sources.
If well developed and implemented, annuity products can significantly reduce old-age poverty and provide financial dignity for retirees as envisaged under the three-tier pension scheme.
